WORKING PAPER

PUTTING A PRICE ON CARBON: A HANDBOOK FOR U.S. POLICYMAKERS

KEVIN KENNEDY, MICHAEL OBEITER, AND NOAH KAUFMAN

EXECUTIVE SUMMARY Putting a Price on Carbon: A Handbook for U.S. CONTENTS Policymakers is the first in a series of papers that the Executive Summary...... 1 World Resources Institute will produce with the aim of 1. Introduction...... 6 providing a clear and comprehensive understanding of 2. Basics of Pricing Carbon...... 7 the key issues that will need to be addressed if the United States ultimately imposes a national price on carbon. The 3. A Brief History of Carbon Pricing...... 12 Handbook lays out what is already known about the design 4. Key Design Features...... 17 and effects of different approaches to pricing carbon, with a 5. Commonly Proposed Uses of focus on carbon taxes and cap-and-trade programs. Carbon Pricing Revenues...... 24 We believe that pricing carbon should be a core element 6. Economic Effects of a Carbon Price...... 34 of the United States’ long-term strategy for achieving 7. Conclusion...... 40 significant reductions in greenhouse gas emissions in the Appendix...... 42 coming decades. However, in writing the Handbook, we recognize that many who are, or could become, interested Bibliography...... 45 in carbon pricing might be motivated by the potential Endnotes...... 48 for benefits that are unrelated to climate change. Carbon price programs can be designed with an eye toward other possible policy goals, such as reforming the tax code to be Working Papers contain preliminary research, analysis, more efficient. Even when carbon pricing is approached findings, and recommendations. They are circulated to with non-climate priorities in mind, the emission reduc- stimulate timely discussion and critical feedback and tion potential provides an insurance policy against the risk to influence ongoing debate on emerging issues. Most of significant climate impacts. working papers are eventually published in another form and their content may be revised. The Handbook provides an overview of carbon pricing— the types of decisions that need to be made in designing a Suggested Citation: Kennedy, K., M. Obeiter, and N. program (including the political decisions about the use of Kaufman. 2015. “Putting a Price on Carbon: A Handbook for U.S. revenue) and the expected economic impacts of alternative Policymakers.” Working Paper. Washington, DC: World Resources approaches. We conducted a thorough review of the Institute. Available online at http://wri.org/carbonpricing. literature, selecting a broad array of well-regarded and highly cited studies that represent a range of viewpoints. We expect this Handbook to be useful in the public debate in the United States on whether, how, and when to implement a national carbon price.

WORKING PAPER | April 2015 | 1 The Basics of Pricing Carbon In California, some money from the cap-and-trade allowance auctions is returned to electricity custom- Greenhouse gas emissions impose costs on the global ers in the form of rebates on their bills. These types of community via climate change. A carbon price shifts the approaches could also ensure that low-income house- burden of these costs from society as a whole to the enti- holds receive at least as much in income as they spend ties responsible for the emissions, providing an incentive on the tax. to decrease carbon emissions. DEFICIT REDUCTION. Large national deficits can reduce Pricing carbon increases the prices of goods across the ▪▪ economic growth rates by increasing interest rates, economy in proportion to their carbon content, and thus inhibiting (or “crowding out”) private sector invest- in proportion to their effect on climate change. By raising ments, and increasing future tax burdens to pay off the relative price of carbon-intensive goods (for example, the principal or interest on the debt. Carbon pricing fossil fuels), a carbon price encourages individuals and revenues could be used to reduce annual deficits and businesses to purchase less carbon-intensive alternatives. thereby help to avoid such adverse economic effects. A carbon price would lead to reductions in U.S. green- INVESTING IN COMBATING CLIMATE CHANGE. In addition house gas emissions and create leverage to encourage ▪▪ to its potential to stimulate innovation in low-carbon other countries to reduce their emissions, both of which technologies (for example, renewable energy), a are necessary to prevent the more severe effects of climate carbon price can provide revenue to help promote the change. In addition, reduced fossil fuel usage will provide development and deployment of breakthrough tech- “co-benefits” in the form of reduced emissions of other nologies. In addition, carbon-pricing revenues can be harmful air pollutants. used to invest in infrastructure that helps communi- While pricing carbon implies higher prices for certain ties adapt to the effects of climate change that are now goods, the additional costs to individuals and businesses unavoidable (extreme weather, sea level rise, etc.). become an additional source of revenue that can either TRANSITIONAL ASSISTANCE. A portion of the revenues be returned to households or spent in other productive ▪▪ can be used to assist those likely to be most adversely ways. Among other possibilities, carbon-pricing revenues affected by a carbon price. Job training can be provided can be used to promote economic growth, advance low- to workers in industries with anticipated job losses carbon technologies and other activities that help respond (for example, coal mining). In addition, revenues can to climate change, and reduce adverse economic effects of be disproportionately allocated to households and the carbon price. business in regions of the country that are most heav- The following are some of the specific potential uses of ily dependent on the production or consumption of carbon pricing revenues: fossil fuels in order to smooth the transition to a lower carbon economy. Revenues can also be used to pro- TAX CUTS. The revenues from carbon pricing could be vide assistance to industries that might face increased ▪▪ used to fund cuts in other tax rates. Taxes on labor competition from foreign competitors. and capital can reduce the income of individuals and businesses and decrease incentives to engage in Many other ways are available to make use of carbon- productive activities such as work and investment. pricing revenue. While many advocates strongly favor Such taxes differ from a carbon tax, which corrects one or another particular approach to the use of revenue, for a market failure and reduces the incentive to emit existing or proposed carbon-pricing policies often include harmful greenhouse gases. a mixture of approaches in accordance with the compro- mises and trade-offs required to pass such far-reaching RETURNING MONEY TO HOUSEHOLDS OR ELECTRICITY legislation. ▪▪ CONSUMERS. Revenue from carbon pricing could be returned to households by sending them “lump sum” Carbon Taxes versus Cap-and-Trade payments, which could be divided equally or by some This Handbook focuses on the two main approaches to alternative metric. This “tax-and-dividend” approach pricing carbon: carbon taxes and cap-and-trade programs. has gained popularity largely because of its perceived A carbon tax is a fee added to the price of goods in propor- fairness and simplicity. Households could be provided tion to their carbon content. A cap-and-trade program with tax refunds or sent quarterly or annual checks.

2 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

entails setting a maximum level of carbon emissions, with Program provided proof of concept for cap and trade, emissions allowances issued by regulators up to this cap which has since been used for pricing carbon. that can be bought or sold. Under a cap-and-trade pro- gram, the carbon price is equal to the market price of the The European Union established its Emissions Trading Scheme in 2005, which is the world’s largest CO cap-and- emissions allowances. 2 trade program.3 The EU-ETS went through a rocky initial If properly designed and implemented, both carbon taxes phase, which saw prices collapse due, in part, to the over- and cap-and-trade programs provide incentives to under- allocation of allowances. However, the program has since take the lowest cost abatement opportunities (those less achieved a stable market for allowances and meaningful expensive than paying the carbon price). In addition, car- emissions reductions, and has provided useful lessons for bon taxes and cap-and-trade programs require a number other cap-and-trade programs developed elsewhere. of similar decisions to be made in the design process. Back in the United States, starting with the Climate While the effects of comparably stringent carbon taxes and Stewardship Act of 2003, Congress has seen numerous cap-and-trade programs are virtually identical in theory, carbon pricing proposals, many with bipartisan sponsor- a number of practical differences exist between the two ship and support. The 111th Congress (2009 and 2010) policy instruments. A carbon tax is in some ways simpler was the high-water mark for these proposals, when the than a cap-and-trade program. A tax does not require the American Clean Energy and Security Act (ACES) cap- government to allocate or conduct auctions for emissions and-trade program (also known as “Waxman-Markey” allowances, or monitor the trading of allowances, and after its two principal co-sponsors) was approved by the regulated entities do not need to participate in auctions or House of Representatives. While several companion bills secondary markets for allowance trading. were introduced in the Senate during that Congress, none moved to a floor vote. Additional carbon-pricing bills have The major advantage of a cap-and-trade program is that been introduced in Congress since 2010, but none has the policy sets a firm limit on the quantity of emissions been given serious consideration. that will be allowed. Therefore, when climate change goals are stated in terms of emissions levels, the emissions cap With little prospect of comprehensive federal action on can ensure the goal will be achieved. A carbon tax can- climate change in the mid-2000s, many U.S. states began not guarantee a certain emissions path, but it will lead to to plan their own state or regional cap-and-trade pro- a certain price pathway. Regulated entities might prefer grams. The first was the Regional Greenhouse Gas Initia- that approach to the less stable prices of a cap-and-trade tive (RGGI), a cap-and-trade program for CO2 emissions program, which can make business planning more dif- from power plants, launched in 2009 by ten northeastern ficult. To that end, cap-and-trade programs may include states (New Jersey has since withdrawn). Various western “ceilings” and/or “floors” on allowances prices to reduce U.S. states and Canadian provinces created the Western price volatility. Climate Initiative (WCI) in 2007 and jointly agreed on design principles for a regional cap-and-trade program. Carbon-Pricing Policies and Proposals While the WCI was never able to implement the regional While the concept of carbon pricing dates back to eco- program, California and Quebec currently operate a linked nomic theory from the early 20th century, in practice, cap-and-trade program that covers 85 percent of the emis- carbon-pricing programs were first developed in the early sions in each jurisdiction. Ontario recently announced its 1990s when four Scandinavian countries implemented intent to establish a cap-and-trade program and link it with California and Quebec as part of the WCI.4 In addi- taxes on carbon dioxide (CO2) emissions. In the United States, the Clinton administration proposed a tax on the tion, WCI member British Columbia established a carbon energy content of fuels that would have been similar to a tax in 2008 that is currently C$30 per ton of CO2 across carbon tax, but the proposal was controversial and with- sectors representing 70 percent of total emissions. drawn in 1993.1 Nearly 40 countries and over 26 sub-national jurisdictions Also in the 1990s, the United States implemented the have implemented either a carbon tax or a greenhouse- Acid Rain Program, which put in place a cap-and-trade gas cap-and-trade program; these include seven pilot program for sulfur dioxide emissions in the United States.2 programs in China. Together, these programs cover While not focused on carbon emissions, the Acid Rain approximately 12 percent of global greenhouse gas (GHG)

WORKING PAPER | April 2015 | 3 emissions. In contrast to the situation a decade ago, if the government, verification of the emissions reports is United States were to establish a national carbon price it essential. Different approaches to that verification are would no longer be a lone actor; instead, it would be join- possible—from independent third party verification to ing a growing community of nations committed to reduc- self-certification with strong penalties. ing global greenhouse gas emissions with cost-effective climate-change policies. SETTING THE PRICE OR CAP. Carbon tax and cap-and- ▪▪ trade programs require setting pathways of prices Carbon Pricing Design Features or emissions caps. Setting the level of the tax or cap will likely require balancing a variety of political, Establishing a carbon pricing program requires many economic, and environmental considerations. From a decisions on policy structure and design. Some of the main climate perspective, one can start from either consid- design elements of a carbon-pricing policy are highlighted eration of emission targets or from estimates of the below. Each element is relevant to both a carbon tax and a damages caused by GHG emissions. For non-climate cap-and-trade program. policy priorities (for example, tax reform), setting SCOPE. Scope refers to the portion of overall green- the price might have more to do with the amount of ▪▪ house gas emissions covered by the program. Deter- revenue needed to serve those priorities. It is common mining a program’s scope requires policymakers to to increase the stringency of a program gradually over time to allow businesses and consumers to adjust, and decide: (1) whether the program covers only CO2 or other greenhouse gases as well; (2) which economic to maintain some flexibility to adjust the price or cap sectors are covered by the program; and (3) whether in the event that conditions change. all emitters or only those above a certain threshold of Various additional factors must also be considered. For emissions are regulated. The broader the scope, the example, allowing “offsets” (emissions reductions from greater the emissions reductions that will be expected entities that are not directly covered by the policy, for from a given carbon price. A broader scope also im- example, enhanced carbon sinks achieved by tree plant- plies that a given quantity of emissions reductions will ing) can reduce the costs of a policy, but can also make the be achieved at a lower cost. emissions reductions more difficult to verify. POINT OF REGULATION. Carbon pricing can be applied at Policymakers should also consider the broader policy con- ▪▪ different points in the economy. Under an “upstream” text in which carbon pricing is introduced, including any approach, the carbon price is applied where the ma- complementary policies that might be needed to further terials that will result in the emissions first enter the reduce emissions or costs. economy (for example, at the coal mine, the oil or gas drilling site, or the entry point of fuel imports). Such Economics of Carbon Pricing an approach enables a large fraction of energy CO2 emissions to be covered while regulating relatively few The body of literature on the economic effects of carbon entities. A “downstream” approach applies the carbon pricing programs is wide and deep. Economists have con- price at the point where the emissions actually occur. ducted both benefit-cost and economic-impact analyses to This is straightforward to implement for power plants assess the effects of carbon taxes on society as a whole and and manufacturing facilities, but far more difficult for on individual sectors, regions, and income levels. While individual buildings, cars, and trucks. A program may there are serious limitations to economic models (see also include a mixture of upstream and downstream Section 6 for detail), economic theory and empirical approaches, or “midstream” approaches (for example, results can nonetheless offer important lessons to policy- oil refineries and natural gas processing plants). makers as they design carbon-pricing programs.

REPORTING AND VERIFICATION. A key prerequisite for a Benefit-Cost Analysis ▪▪ successful carbon pricing policy is a robust emissions The most important finding of economic theory related reporting and verification system. Reliable reporting to carbon pricing is also the most basic: when an activity systems are often already in place for other purposes. such as emitting greenhouse gases causes harm that is not Because the addition of a carbon price creates direct reflected in the prices of goods and services (what econo- economic consequences for both the covered entity— mists call a “negative externality”), pricing that activity which wants to minimize its tax burden—and the leads to reductions in the activity and to overall gains

4 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

in welfare. The price corrects for the market failure (the The economic impacts of a carbon price (in terms of harm caused is internalized in the costs of the goods and economic growth, employment, etc.) are highly contingent services). Indeed, economic studies show that the optimal on how the revenue is spent. Economists have found that carbon price is potentially very large.5 maximizing economic growth requires using the revenue to remove pre-existing “distortions” in the economy that Climate change is a challenging economic problem, in part serve to hinder growth.8 For example, economic stud- because benefits are global in nature while policy costs ies have shown that lower income tax rates (corporate are local. This dilemma has caused some to question the and personal) would cause individuals to work more and benefits achievable from a carbon price established by corporations to create more jobs. Revenue can also be any single country. On the other hand, many nations and used to achieve many other objectives, such as investing in sub-national jurisdictions have already put a carbon price technologies that spur low carbon innovation and climate in place. The United States is responsible for a significant change adaptation, or providing transitional assistance to portion of global greenhouse-gas emissions, and U.S. sectors, regions, and individuals that are most vulnerable adoption of a carbon price could help spur broader multi- to the higher prices and lower demand for carbon- national action to combat climate change. intensive goods.

Comparisons of the benefits and costs of carbon pric- Recent studies have shown that neither the distributional ing should take account of benefits unrelated to climate consequences,9 the regional disparities,10 nor the effects change. For example, reduced fossil fuel usage provides on the competitiveness of U.S. industry11 are as large as substantial “co-benefits” in the form of reduced emissions some have feared. Still, using a portion of the revenues to of other harmful air pollutants. In addition, the carbon address either the actual or perceived “losers” from a car- pricing revenues can be used in a variety of ways to benefit bon price may increase the fairness and political viability the economy and boost economic growth. of the policy. For all these reasons, economists overwhelmingly support Next Steps a well-designed national carbon tax. In 2012, a University of Chicago survey asked 40 prominent economists from While we can’t predict what the future may hold, con- across the political spectrum whether they would prefer versations with policymakers, stakeholders, and others the government to raise revenue through traditional highlight several factors that could combine to increase income taxes or via a national carbon tax. Not one chose the appeal of carbon pricing policies across the political the income tax approach.6 spectrum in coming years. While views differ sharply on some of these, factors that might interest people of differ- Economic Impacts ent political views include: While economists largely agree that many uses of carbon- Bipartisan support for tax reform; pricing revenues can promote long-term prosperity, ▪▪ determining whether a carbon price will be beneficial to Successful carbon-pricing programs at the state and the U.S. economy in the short run is a more difficult ques- ▪▪ regional levels, including the potential for more pro- tion. A significant portion of the welfare gains will accrue grams spurred by compliance with the new EPA power outside the economy (if these gains are measured tradi- plant standards; tionally, using metrics such as national GDP) and will not be realized until far into the future. Nevertheless, because Increased awareness of the current and impending of the various non-climate policy objectives that can be ▪▪ impacts of climate change; achieved with the revenue from a carbon price, economists Stated goals for deeper greenhouse-gas emissions have found that at least some of the potential adverse ▪▪ cuts; and economic consequences for specific sectors, regions, or groups can be offset. In fact, some economists have Desire by some for an alternative approach to found that a properly designed carbon price can achieve ▪▪ regulating carbon. net economic benefits, even before consideration of the climate benefits, which economists refer to as a “double Cap-and-trade programs are already in place in the north- dividend.”7 eastern United States and California. However, following the failure of the U.S. Senate to pass climate legislation in

WORKING PAPER | April 2015 | 5 2010, talk in Washington D.C. about pricing carbon has grams can be designed with an eye toward other policy shifted from cap-and-trade to carbon taxes. These dis- goals, such as reforming the tax code to be more efficient. cussions have involved a wide range of players, but have Viewed in this way, the potential for emissions reduc- remained quiet and behind the scenes. A key question in tion can be seen simply as a side benefit or an insurance coming years will be whether, and when, these discus- policy against uncertain but potentially significant climate sions will again be considered part of mainstream political change impacts. discussion. Because carbon pricing can aim at a variety of policy We believe that pricing carbon should be a core element of objectives, support for some form of pricing carbon comes the United States’ response to climate change because of from divergent points on the political spectrum. Though the massive environmental and economic benefits it can they disagree on the details, supporters include former offer. Any such policy will result in winners and losers; Secretary of State George Schultz,12 former Treasury it is therefore critical that any program be designed to Secretary Henry Paulson,13 and former Republican Con- recognize and address the potential for uneven distribu- gressman Bob Inglis;14 conservative economists such as tion of benefits and costs. This paper highlights the major Gregory Mankiw15 and Art Laffer;16 scholars at the Ameri- tools available for dealing with these concerns. These tools can Enterprise Institute,17 Resources for the Future,18 and also provide the opportunity to satisfy a variety of politi- the Brookings Institution;19 and organizations such as cal goals beyond emissions reductions. We hope that this the Center for American Progress,20 the Citizens’ Climate working paper—and future issue briefs that will dive more Lobby,21 and the Niskanen Institute.22 deeply into many of the topics discussed here—will play a helpful role in the coming national conversation on these The Handbook provides an overview of carbon pricing— issues. the types of decisions that need to be made in designing a program (including the political decisions about the use of revenue) and the expected economic impacts. This 1. INTRODUCTION overview provides basic information aimed at improving understanding of important trade-offs inherent in pricing Putting a Price on Carbon: A Handbook for U.S. carbon (for example, between ease of implementation and Policymakers is offered in the expectation of continued comprehensiveness of coverage), though it is beyond the debate in the United States over how to address climate scope of the paper to attempt to resolve them. For those change. While current policy actions focus on regulatory new to thinking about pricing carbon, the Handbook can approaches, we believe that putting a price on carbon serve as a basic primer. For those who have been deeply needs to be a core element of the United States climate involved in prior legislative debates on climate legislation policy in the long term. The Handbook is the first in a or in research and discussions of cap-and-trade programs series of papers that the World Resources Institute will or carbon fees and taxes, this Handbook provides a broad produce in coming years with the aim of providing a clear refresher and reference work. We expect that this type of and comprehensive understanding of the key issues that reference work will be useful when public debate in the will need to be addressed if the United States ultimately United States turns toward whether, how, and when to chooses to impose a national price on carbon. The Hand- implement a national carbon price. book sets out what is already known about the design and effects of different approaches to pricing carbon, with the In writing this paper, the authors conducted a thor- main focus being on carbon fees or taxes and cap-and- ough literature review, selecting a broad array of well- trade programs. regarded and highly cited studies that represent a range of viewpoints. Our exploration of carbon pricing was The starting point for most discussions of a carbon price also informed by a number of conversations—many off is its role in addressing greenhouse gas emissions and the record—with carbon-pricing proponents from across reducing the future effects of climate change. However, the political spectrum. Future research by the World in writing the Handbook, we recognize that not all those Resources Institute will explore in more detail some of who are or might become interested in carbon pricing the economic opportunities presented by carbon pricing, are motivated by climate science and the need to reduce such as encouraging innovation, and how to evaluate and greenhouse gas (GHG) emissions in order to avoid the address some of the potential downsides, for example, worst impacts of climate change. Carbon-pricing pro-

6 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Box 1 | What is a “Carbon Price?” carbon price based on other priorities are welcome and needed to move the debate forward. We look forward to a wide-ranging and productive set of discussions in the In this Handbook, the term “carbon price” is being applied coming years. both broadly–to include all greenhouse gases—and narrowly— limited to two mechanisms that explicitly result in a price on This paper explores how various design decisions and carbon emissions. possible uses of carbon revenues can address other policy A “carbon price” is sometimes understood to apply to carbon priorities in addition to climate change. The paper begins

dioxide (CO2) emissions only. In the context of this paper, we with an overview of carbon pricing (Section 2), followed by will refer generically to greenhouse gases as “carbon” so a car- a brief history of experience with carbon pricing programs bon price can apply beyond CO . See section 3 for a discussion 2 in the United States and elsewhere (Section 3). Section of policy design issues related to including greenhouse gases other than CO in a carbon pricing system. 4 then walks through the main decisions that must be 2 made to design and implement a carbon-pricing program. This Handbook focuses specifically on carbon taxes (or fees) Section 5 explores the various uses of revenue that have and cap-and-trade programs. Both focus on greenhouse gas been tried or considered as part of different carbon pricing emissions, and result either directly or indirectly in an explicit programs and proposals, and Section 6 provides a sum- price on carbon emissions. A carbon tax or fee would directly establish a price on carbon emissions in dollars per ton of mary of the literature on the main economic impacts from emissions. While this price could be applied at the point carbon pricing. Conclusions are presented in Section 7. By of emissions, many proposals focus on applying the price providing clear analysis of what can be achieved through “upstream”—at “chokepoints” where fossil fuels enter the different approaches to pricing carbon, this paper hopes broader economy—and are based on the carbon content of the to guide thinking on how to design a proposal for pricing fuels. A cap-and-trade program establishes the price indirectly by placing a limit on the total quantity of emissions that will carbon to achieve multiple objectives. be allowed. This limit is enforced based on tradable emission permits, typically called “allowances,” that any emissions source must use to cover its emissions. Like a carbon tax, the cap could be applied downstream at the point of emissions, 2. THE BASICS OF PRICING CARBON upstream where fuels enter the economy, or at points in the distribution system in between. The market for these allow- 2.1. Why Price Carbon? ances creates the carbon price in a cap-and-trade program. Pricing carbon can provide an economically efficient Other types of programs can be used to place a price on means of reducing greenhouse gas emissions and mini- carbon, including programs that are based on emission mizing the disruptive risks of climate change. A carbon intensity (rather than actual emissions) such as the Specified price provides a relatively simple and direct way to ensure a Gas Emitters Regulation (SGER) program in Alberta, Canada. that more of the costs of climate change are brought into In addition, a program such as a clean energy standard that includes trading provisions based on carbon intensity could the economic calculus behind investments and consump- also result in an effective price on carbon. Some discussions tion, including resource and fuel use. It sends a price of carbon pricing also include consideration of fossil fuel and signal that could influence widely dispersed economic other energy subsidies, which can have an important effect on decisions, help guide future economic growth toward a the relative cost of different fuels. lower carbon economy, and reduce the impacts of climate Note: change over time. a. World Bank, State and Trends of Carbon Pricing 2014. Support for carbon pricing also comes from parties who might be motivated by policy priorities other than the the potential for regional or income disparities that could need for action on GHG emissions, but who see the value arise from a carbon price. of an insurance policy against climate risks. Policy priori- ties that can be addressed through some form of carbon This work is intended to seed an ongoing productive pricing include: discussion and debate on the pros and cons of different approaches to pricing carbon. While the World Resources REDUCING GREENHOUSE GAS EMISSIONS. A carbon price Institute sees reducing greenhouse gas emissions to ▪▪ can help reduce GHG emissions by internalizing reduce the impacts of climate change as a critical prior- the costs of climate change in economic decisions ity, the views and input of those interested in exploring a throughout the economy.

WORKING PAPER | April 2015 | 7 SPURRING INNOVATION IN CLEAN ENERGY. By reflecting not only take money away from individuals and busi- ▪▪ the cost of carbon in the prices for fuels and goods, a ness, but also decrease incentives to engage in produc- carbon price can send an economic signal that helps tive activities such as work and investment. Such taxes spur investment and innovation in energy sources and differ from a carbon price, which reduces the incen- new technologies that are less carbon intensive. tive to emit harmful greenhouse gases. The decision on which taxes to cut (for example, payroll, personal REDUCING OTHER TAXES. ▪▪ Revenue from pricing carbon income, or corporate income taxes) may involve trade- can be used to reduce other taxes. This can be done offs between cost-effectiveness and distributional in a revenue-neutral way that moves from taxing concerns. things we want more of (for example, employment or income) to taxing those we want less of (for example, RETURNING MONEY TO HOUSEHOLDS OR ELECTRICITY GHG emissions). Options include reductions in pay- ▪▪ CONSUMERS. Revenue from carbon pricing could be roll, personal income, or corporate income taxes in aid returned to households by sending them “lump sum” of broader tax reform. payments, which could be divided equally or by some alternative metric. This “fee-and-dividend” approach RAISING REVENUE FOR OTHER PRIORITIES. ▪▪ Carbon rev- has gained popularity largely because of its perceived enues can also help to address other policy priorities. fairness and simplicity. Households could be provided For example, revenues could be directed to supporting with tax refunds or sent quarterly or annual checks. research and development, adapting to climate change This approach could also ensure that low-income impacts, investing in infrastructure maintenance and households receive as much in income as they spend improvements, or providing job training or other on the tax. However, such payments are unlikely to targeted support for industries or regions that are boost economic growth as much as cutting tax rates, disproportionately affected by the carbon price. because they do not enhance incentives to work or In addition to these priorities, reducing GHG emissions invest. can improve energy security, reduce direct energy costs, DEFICIT REDUCTION. Large national deficits can slow 23 and help reduce other forms of pollution. While vari- ▪▪ economic growth by increasing interest rates, reduc- ous tools are available to address other forms of pollu- ing (or “crowding out”) private sector investments, tion directly, the reductions that result from a carbon and increasing future tax burdens because of the price have the potential to provide meaningful local and need to pay off the principal or interest on the debt. 24 regional public health and environmental benefits. Carbon-pricing revenues could be used to pay down the debt and therefore avoid such adverse economic 2.2. Uses of Revenue effects. Just as reducing current tax rates can increase While pricing carbon implies higher prices for certain incentives to work and invest, reducing future tax goods, the additional costs to individuals and businesses rates through deficit reduction could have similar pro- become an additional source of revenue that can either be growth effects. returned to households or spent in other productive ways. ENCOURAGING INNOVATION IN LOW-CARBON TECHNOLO- Among other possibilities, carbon-pricing revenues can ▪▪ GIES. While a carbon price can help stimulate innova- be used to promote economic growth or employment, to tion in low-carbon technologies (for example, energy advance low-carbon technologies and other activities that efficiency or renewable fuels), additional support for help combat and prepare for climate change, or to reduce innovation might be needed to mitigate the effects any potential adverse effects of the carbon price on specific of climate change. Moreover, to the extent that the groups. private sector “underinvests” in research and develop- ment because it cannot capture the public benefits of The following summarizes some of the specific potential R&D, further government support might be required uses of carbon-pricing revenues: to promote the development of breakthrough tech- nologies. Carbon-pricing revenues could be a source of TAX CUTS. The revenues from carbon pricing can be such funding. ▪▪ used to fund cuts in income taxes, which increase incentives to work and invest, and therefore boost eco- nomic growth as a result. Taxes on labor and capital

8 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Box 2 | How a Carbon Price Works

The impacts of climate change resulting but have lower carbon-emission footprints. than on less carbon-intensive natural gas, from greenhouse gas emissions impose and no effect on non-carbon nuclear and costs on society as a whole. Pricing As a simplified illustration of this type of renewable sources. The increased fuel carbon shifts these costs away from the shift, Figure 1 shows the impact of a carbon prices—which now reflect the adverse

broader society to those responsible for the tax of $25 per ton of CO2 on the levelized effects of climate change—would then be emissions, while providing an incentive to cost of electricity (LCOE). LCOE is a passed on in full or in part in any products reduce emissions. standard measure for comparing the lifetime for which the fuels are an input. costs of building and operating different Putting a price on carbon across the electricity generation options, though it These shifts increase the competitiveness of economy will increase the prices of goods does not reflect the dynamics of wholesale less carbon-intensive sources (see Figure and services in proportion to their carbon electricity markets that drive electricity rates. 1). In addition, less efficient generation content, and so in proportion to their effect The carbon tax reflects the relative impact methods (such as the natural gas turbine)

on climate change. The higher prices for of each fuel on CO2 emissions, so the tax see a greater price increase than more carbon-intensive goods and services will has a larger effect on carbon-intensive coal efficient options (such as natural gas encourage businesses and consumers to (the fuel that creates the highest carbon combined cycle). look for alternatives that meet their needs emissions per unit of energy when burned)

FIGURE 1 | EFFECT OF CARBON TAX ON AVERAGE COST OF NEW U.S. ELECTRICITY GENERATION FOR PLANTS ENTERING SERVICE IN 2019 (2012 $/MWH)

$150 LCOE w/o tax ($/MWh) tax ($/MWh)

$120

$90

$60

$30

$0 Conventional Conventional Conventional Advanced Wind Solar Coal Natural Gas Natural Gas Nuclear Photovoltaic Combined Cycle Turbine

Sources: “Levelized Cost and Levelized Avoided Cost of New Generation Resources in the Annual Energy Outlook 2014,” U.S. Energy Information Administration, April 17, 2014, http://www.eia.gov/forecasts/aeo/electricity_generation.cfm. The tax increment is based on heat rates from EIA (“Table 8.2. Average Tested Heat Rates by Prime Mover and Energy Source, 2007-2013,” U.S. Energy Information Administration, accessed April 13, 2015, http://www.eia.gov/electricity/annual/html/epa_08_02.html) and the emissions per Btu from EIA (“How Much Carbon Dioxide is Produced When Different Fuels Are Burned?,” U.S. Energy Information Administration, accessed April 13, 2015, http://www.eia.gov/tools/faqs/faq.cfm?id=73&t=11). Note: Levelized cost of electricity data in the figure are based on U.S. average levelized costs for plants entering service in 2019 from the 2014 Annual Energy Outlook.

WORKING PAPER | April 2015 | 9 CLIMATE CHANGE ADAPTATION. While carbon pricing Many other options are available. While many of those ▪▪ can help to mitigate the adverse effects of climate who support pricing carbon are champions of particular change, some impacts—according to the IPCC—are uses of carbon-pricing revenues, many carbon-pricing now unavoidable. For that reason, some proponents policies and proposals reflect a mix of approaches. of carbon pricing support the use of revenues to invest in infrastructure that helps communities adapt to the 2.3. The Basics of Cap-and-Trade and impacts of climate change. Such investments could in- Carbon-Tax Programs clude increasing the resiliency of water, transport, and energy systems, as well as other infrastructure that is Carbon taxes and cap-and-trade programs require a num- vulnerable to extreme weather, sea-level rise, and the ber of similar decisions to be made in the design process. other effects of a changing climate. These decisions often involve trade-offs: increasing the scope of a program beyond a certain level usually implies TRANSITIONAL ASSISTANCE FOR AFFECTED SECTORS, increasing the burden of administering it; programs with ▪▪ INDIVIDUALS, AND REGIONS. By inducing changes in more stringent emissions targets will cause larger impacts behavior and purchasing patterns, pricing carbon is on the economy; implementing mechanisms to “smooth” likely to benefit certain industries and regions more these economic impacts will generally increase either than others. A portion of the revenues is often used to compliance costs or emissions. assist those who are likely to be adversely affected by a carbon price. Job training can be provided to workers A carbon tax is in some ways simpler than a cap-and-trade in industries that experience job losses (for example, program, especially for the companies that would have to coal mining), and revenues can be disproportionately operate under the system. An emissions cap can ensure allocated to households and business in regions of the that emissions targets are met, while a carbon tax can country that are most dependent on the production or ensure a stable trajectory of prices. Table 1 provides an consumption of fossil fuels. Revenues can also be used overview of the main similarities and differences between to provide assistance to industries that face increased the two systems,25 while Section 4 provides a short primer competition from competitors in foreign countries on designing a carbon-price system. without (or with lower) carbon prices.

Table 1 | Important Design Features of a Carbon Tax Versus a Cap-and-Trade Program

CARBON TAX CAP-AND-TRADE PROGRAM

What is the scope? Both involve similar decisions regarding the choice of gases to regulate, which sectors to regulate, whether to al- low relatively small emitters to remain unregulated, and where the regulation occurs (upstream, downstream, etc.). Such decisions often involve trade-offs between emissions reductions and feasibility and administrative burdens

How is a carbon price The price is the tax level The price is the market price of emissions allowances (which established? can be estimated via modeling)

What emissions reductions Depends on the response to the change in Maximum emissions established by setting the trajectory of can be achieved? prices (which can be estimated via modeling) emissions caps

10 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Table 1 | Important Design Features of a Carbon Tax Versus a Cap-and-Trade Program (continued)

CARBON TAX CAP-AND-TRADE PROGRAM

How do regulated entities Must report emissions (or a proxy for emis- Must report emissions (or a proxy) and surrender allowances comply? sions such as fuel quantities) and pay the tax ▪▪ based on those emissions based on those emissions Obtain allowances by direct allocation, through purchase at ▪▪ auction, or in the secondary market Participate in secondary market as buyer and/or seller of ▪▪ allowances Bank allowances for future use or borrow for current use (if ▪▪ permitted under the regulation)

How much will it cost Future compliance costs based on emissions Future compliance costs based on emissions and estimated regulated entities to and established tax rates ▪▪ allowances prices comply? Costs also depend on the degree to which allowances are ▪▪ allocated at no charge, versus bought at auction or on the secondary market

Can offsets lower In theory, either policy could allow regulated entities to purchase emissions offsets (that is, verified emissions compliance costs? reductions from non-covered sources) in lieu of direct compliance, which will lower compliance costs. Offsets are more commonly seen as part of cap-and-trade programs

Where will regulated Where the cost of emissions reductions is Where the cost of emissions reductions is less than the cost entities reduce their less than the cost of paying the tax, taking into of buying (or the opportunity cost of not selling) allowances, emissions? account the trajectory of future taxes taking into account the trajectory of expected future allowance prices

What is the role of A carbon tax would not create a market that A mechanism for auctioning allowances (unless all are markets, and which market needs to be regulated ▪▪ distributed at no charge) protections are needed? A secondary market with proper oversight and regulation (a ▪▪ liquid secondary market that sends a transparent price signal to regulated entities is needed for an efficient program)

What happens to the Both a carbon tax and a cap-and-trade program (assuming some degree of auctioning of permits) will generate revenue? revenue, and the government can stipulate how the revenue is to be spent (for example, reduced taxes, deficit reduction, spending on other programs). While the same alternatives will be available under either policy type, revenue amounts are likely to be more predictable under a carbon tax

How does the Complementary policies can achieve emis- Complementary policies shift the location of emissions in the system interact with ▪▪ sions reductions beyond those achieved by ▪▪ economy, but the cap establishes the maximum overall level of complementary policies a carbon tax, for example, if a renewable emissions for covered sectors (for example, a Renewable portfolio standard requires more renewable Complementary policies may be desirable even within covered Portfolio Standard)? power than would be deployed with the ▪▪ sectors, for example to encourage innovation or deployment of carbon tax alone new technologies in certain sectors Complementary policies may be desirable, ▪▪ even within covered sectors, for example, to encourage innovation or deployment of new technologies in certain sectors

WORKING PAPER | April 2015 | 11 3. A BRIEF HISTORY OF opened Gus Speth’s foreword to The Right Climate for Carbon Taxes,26 published by the World Resources CARBON PRICING Institute in August 1992, in the wake of the climate treaty “Taxing carbon dioxide emissions may be an idea whose signed by more than 150 nations in Rio de Janeiro that time is at hand in the United States, now that reducing April. While the Clinton administration, as part of its first greenhouse gas emissions has become an international budget, proposed a tax on the energy content of fuels that imperative.” These hopeful—but premature—words would have had similarities to a carbon tax on energy,27

Figure 2 |  Timeline of Carbon Pricing Programs from Around the World

1990 Finland

1992 Denmark Carbon Taxes 1991 2008 Sweden Switzerland

Norway British Columbia

2005 European New Union Zealand

Switzerland

2009 U.S. sub-national programs RGGI (NE U.S.) Cap-and-Trade Programs Cap-and-Trade

12 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

that proposal was highly controversial and withdrawn by Earth Summit, however, many countries and sub-national the end of 1993.28 No serious proposals for a carbon tax or jurisdictions have instituted carbon taxes or cap-and-trade greenhouse gas cap-and-trade program were put before programs. Figure 2 lists the carbon-tax and greenhouse Congress for another ten years, though the 1990s did see gas cap-and-trade programs that since have been insti- the successful implementation of the acid rain cap-and- tuted around the world. trade program (see Box 3). In the years since the Rio

Figure 2 |  Timeline of Carbon Pricing Programs from Around the World (continued)

2012 Japan

2010 2014 2016 Ireland France South Africa (extended to solid Australia (planned) fuels in 2013) Initiated July 2012; Iceland repealed in Mexico 2014 2013 2018 United Chile Kingdom (planned)

2015 Australia South Korea 2012; repealed 2014 China Chongqing sub-national Hubei pilots

U.S. sub-national program California

Canada sub-national program Quebec

China sub-national pilots Tianjin Beijing Shanghai Guangdong Shenzhen

Kazakhstan

WORKING PAPER | April 2015 | 13 Box 3 | Acid Rain Program: The Origin of Cap and Trade

A cap-and-trade program, limiting total SO2 emitted (and were heavily penalized if alternatives ($3.4 billion to $11.5 billion) and emissions and enabling regulated entities to they did not). Power plants could buy allow- also less than EPA’s initial projection for the buy and sell emissions permits, is among the ances, sell allowances, or “bank” allowances Acid Rain Program ($1.9 to $5.5 billion).b most prominent tools used to price carbon. for use in future years, but could not borrow Still, some people have argued that costs The first major cap-and-trade system was the allowances from future years’ allocations. could have been even lower, were it not for Acid Rain Program, passed by Congress in The emissions cap declined over time toward informational barriers and other state and 1990 to reduce acid rain by regulating sulfur a long-term national goal of 7.6 million tons federal regulations that constrained power

dioxide (SO2) emissions from power plants. of SO2 emissions, which was achieved three plants’ abilities to select the low-cost abate- The majority of previous environmental years ahead of schedule in 2007. ment opportunities.c regulations were “command-and-control,” in that they designated emissions rates or The great advantage of a cap-and-trade Overall, the Acid Rain Program is widely equipment standards for regulated entities. In system is that it facilitates cost-effective seen as a success at many levels. Not only fact, many environmentalists were hostile to emissions reductions. In theory, the plants did it provide large environmental benefits the concept of allowing polluters to pay for with relatively low-cost opportunities to at a relatively low cost,d it also paved the the right to pollute. reduce emissions will do so and sell their way for future cap-and-trade systems that unneeded permits (for a profit) to plants with have focused on carbon emissions. In 2005, The cap-and-trade system at the heart of the higher cost opportunities, which will then the European Union’s Emissions Trading Acid Rain Program arose from collaboration avoid expensive emissions reductions. The Scheme became the first major cap-and-trade between the Environmental Defense Fund Acid Rain Program was the first major test program for greenhouse gas emissions, and (EDF) and the Administration of George H.W. of this theory, and it was highly successful. greenhouse gas cap-and-trade systems have Bush.a Regulated power plants were allocated The best estimates of actual program costs since been established in the northeastern a fixed number of tradable allowances and ($1.17 to $2 billion annually) were less than United States (the RGGI program) and in had to surrender one allowance per ton of the projected costs of command and-control California.

Notes: a. Conniff, R. August 2009. “The Political History of Cap and Trade.” Smithsonian Magazine.[1-3] See: http://www.smithsonianmag.com/air/the-political-history-of-cap-and- trade-34711212/?page=2 b. Siikamäki J., D. Burtraw, J. Maher, and C. Munnings. March, 2012. “The U.S. Environmental Protection Agency’s Acid Rain Program.” Washington, D.C.: Resources for the Future. Working Paper. c. Schmalensee R. and R. Stavins. August, 2012. “The SO2 Allowance Trading System: The Ironic History of a Grand Policy Experiment.” Cambridge, MA: MIT Center for Energy and Environmental Policy Research. d. Cost-benefit analyses have shown that the Acid Rain Program contributed benefits roughly 40 times the costs of the program. Interestingly, nearly 95 percent of the estimated benefits were related to the health impacts of sulfate particulates, which were not well understood until after the implementation of the program (Schmalensee and Stavins, 2012).

3.1. Carbon Pricing in the United States Congresses. While several companion bills were intro- and Canada duced in the Senate during that Congress, none moved to a floor vote. Starting with the Climate Stewardship Act, introduced by Senators John McCain and Joseph Lieberman in 2003, The debate and compromises that led to the passage Congress has seen numerous proposals to cap or tax of ACES in the House provide a useful set of lessons to carbon emissions, many of them with bipartisan sponsor- consider in the context of future proposals to price carbon 29 ship and support. The 111th Congress (2009 and 2010) at the national level in the United States. Putting in place was the high-water mark for these proposals, with the a significant carbon price will result in both winners and passage in the House of Representatives of the American losers even if the policy provides net benefits overall. For Clean Energy and Security Act (ACES), often referred to as the policy to succeed politically and work economically, it “Waxman-Markey” for the names of its chief sponsors— is critical that the program be designed to recognize and then Representatives Henry Waxman and Ed Markey. address, to the extent needed, the uneven distribution This bill benefited from the many precursors in earlier of benefits and costs that it could impose. Much of the

14 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

negotiation and compromise that went into the House With little prospect of comprehensive federal action on passage of ACES related to finding ways of addressing real climate change in the mid-2000s, many states began or perceived costs of the program or finding benefits that working together, including several regional efforts to could bring additional people into the coalition support- create multi-state cap-and-trade programs. The first of ing the bill. This type of major policy initiative can only be these was the Regional Greenhouse Gas Initiative (RGGI), put in place in the U.S. political system by finding ways to a multi-state cap-and-trade program for CO2 emissions satisfy a wide variety of interests. from power plants. The discussions that led to RGGI were initiated in 2003, and the program was launched in 2009 While additional bills have been introduced in Congress by ten northeastern states (New Jersey withdrew in 2012, since then—including the American Opportunity Carbon but New York, Delaware, Maryland, and the New England Fee Act, by Senators Whitehouse and Schatz in November states remain in RGGI). RGGI covers approximately 20 2014,30 and the Healthy Climate and Family Security Act percent of total GHG emissions in the participating states. of 2015 by Representative Van Hollen in February 201531— In February 2013, the RGGI states completed a program as of this writing, none have been given serious consider- review that lowered the 2014 emissions cap by 45 percent ation or a committee hearing. and made additional changes to the cap through 2020.

Box 4 | Carbon Pricing and the Clean Power Plan

In June 2014, EPA proposed the Clean Power is, cap-and-trade) performance standards as carbon generation or investments in energy Plan (CPP) to satisfy its obligation to regulate alternative compliance mechanisms. Under efficiency, and thus a reduction in overall emis- greenhouse gas emissions from existing either approach, a system of tradable emis- sions rates. Using economic modeling (just power plants.a EPA proposed emissions rate sions allowances could reduce the total costs as it would for other compliance strategies), standards, but provided states with significant of compliance by incentivizing those with a state could show that its planned carbon tax flexibility to design their own implementa- high-cost abatement opportunities to purchase would likely achieve the required emissions tion plans. After the CPP is finalized by EPA allowances from those with low-cost abate- rate standard. Carbon taxes are relatively easy in the summer of 2015, states can propose ment opportunities. States and regions with to administer because they do not require implementation plans to EPA by 2016, with pre-existing cap-and-trade programs are likely states to allocate emissions allowances, extensions available to 2017 (for single state to continue these programs to comply with conduct auctions, or monitor allowance trad- plans) or 2018 (for multi-state plans).b EPA will the standard (namely, California, and RGGI in ing. Carbon taxes also provide predictable and also issue a final federal plan in 2016 for areas nine northeastern states), and additional states stable price signals to regulated entities, and a that do not submit a state plan. Within one year may take an interest in carbon pricing as an large source of government revenue that could of a state plan being proposed, EPA will either implementation option. c be used to counteract the cost of the tax to approve the plan or institute its own plan before constituents. Perhaps most importantly, carbon the compliance period begins in 2020. While not explicitly mentioned by EPA, vari- taxes (as well as cap-and-trade programs) are ous commentators have called for the use of more cost-effective than emissions rate stan- States are likely to adopt a variety of ap- carbon taxes as an additional CPP compliance dards (even with multi-state trading programs), proaches to implementing the CPP, including alternative.d By increasing the relative price so enabling states to utilize carbon taxes could pricing carbon. In its proposal, EPA describes of carbon-intensive electricity generation, a significantly lower the compliance costs of the both “rate-based” and “mass-based” (that carbon tax would lead to an increase in low- CPP.e

Notes: a. “Clean Power Plan Proposed Rule,” U.S. Environmental Protection Agency, accessed April 13, 2015, http://www2.epa.gov/carbon-pollution-standards/clean-power-plan- proposed-rule. b. “Fact Sheet: Clean Power Plan & Carbon Pollution Standards Key Dates,” U.S. Environmental Protection Agency, accessed April 13, 2015, http://www2.epa.gov/carbon- pollution-standards/fact-sheet-clean-power-plan-carbon-pollution-standards-key-dates. c. See “Power Plan Hub,” E&E Publishing, accessed April 13, 2015, http://www.eenews.net/interactive/clean_power_plan. d. Wara, M, A. Morris, and M. Darby. October, 2014. “How the EPA Should Modify Its Proposed 111(d) Regulations to Allow States to Comply By Taxing Pollution.” Washington, D.C.: Brookings Institution. e. Fischer, C. 2001. “Rebating Environmental Policy Revenues: Output-Based Allocations and Tradable Performance Standards,” Washington, D.C.: Resources for the Future. Discussion Paper 01-22.

WORKING PAPER | April 2015 | 15 The revisions recommended through the program review these programs represent more than 22 percent of global are intended to strengthen the program in the years GHG emissions, with the programs themselves covering ahead.32 approximately 12 percent of global emissions.35

In 2006, California passed the Global Warming Solutions The longest-running programs are the carbon taxes estab- Act (AB 32), which required it to reduce emissions to lished by Denmark, Finland, Norway, and Sweden in the 1990 levels by 2020. The following year, western states early 1990s. National carbon taxes have also been estab- (including California) and Canadian provinces created the lished in recent years in France, Iceland, India, Ireland, Western Climate Initiative (WCI) and began a regional Japan, Mexico, Switzerland, and the United Kingdom, discussion on the design and implementation of a multi- while South Africa and Chile have approved carbon taxes sector cap-and-trade program. WCI grew to include seven that have not yet taken effect. In addition, British Colum- states and four Canadian provinces, who jointly agreed on bia has enacted a carbon tax at the sub-national level. design principles for a regional cap-and-trade program.33 However, California and Quebec are the only jurisdic- The largest greenhouse gas cap-and-trade program is the tions that have implemented the program to date. They European Union’s Emissions Trading System (or EU ETS), now operate a linked cap-and-trade program that covers initially established in 2005. Other national programs 85 percent of the emissions in each jurisdiction. Ontario are operating in New Zealand, Switzerland, and Kazakh- recently announced its intent to establish a cap-and-trade stan, and one began operation in the Republic of Korea program and link it with California and Quebec as part of in 2015. Sub-national cap-and-trade programs are also the WCI.34 British Columbia (BC) remains a member of operating, with an electric sector program in nine states WCI but does not have a firm plan for joining the linked in the northeastern United States, linked multi-sector cap-and-trade program. BC did establish its own econ- programs in California and Quebec, and seven municipal omy-wide carbon tax in 2008 that is currently set at C$30 and provincial pilot programs under way in China. China 36 per ton of CO2 across sectors representing 70 percent of has begun planning a national-level emissions-trading total GHG emissions in the province. system that is expected to be phased in starting in 2016.37 While significant work remains to be completed, once fully Similar discussions among states and provinces in the operational the Chinese program could be the largest GHG Midwest to form a regional cap-and-trade program were trading program in the world. initiated in 2007, but did not progress far and were sus- pended in 2010. (See Box 4 for discussion of the potential Figure 3 shows the current and planned carbon tax and for carbon pricing as a state implementation measure cap-and-trade programs from around the world, and under EPA’s Clean Power Plan, which is establishing Appendix A provides summary information about those carbon dioxide standards for existing power plants.) programs. Not included in this summary are systems based on carbon intensity, such as the program in Alberta, Since the failure of the Senate to pass climate legislation Canada, or offset programs such as the Clean Develop- in 2010, talk in Washington about pricing carbon has ment Mechanism (CDM). shifted from cap-and-trade—now considered a politi- cal non-starter–to carbon taxes. These discussions have In addition to these government programs, many busi- involved a wide range of players, but have remained quiet nesses in the private sector are already accounting for sub- and behind the scenes. A key question in coming years stantial future carbon prices in their planning decisions. will be whether, and when, these discussions will again be As shown in a recent report by CDP (formerly known considered part of mainstream political discussion. as the Carbon Disclosure Project), a growing number of multi-national corporations representing a diverse set of 3.2. Carbon Pricing Systems Around the World industries and interest have disclosed using an internal carbon price, including BP, Duke Energy, Google, Royal While no national carbon price has been established in the Dutch Shell, Wal-Mart, Walt Disney, and Wells Fargo, United States, almost 40 other countries and over 26 sub- among many others.38 national jurisdictions have implemented carbon-pricing programs. Total GHG emissions in the jurisdictions with

16 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Figure 3 |  Carbon Pricing Programs Around the World

Finland Sweden Iceland Norway Denmark

U.K. Kazakhstan Quebec Ireland British Columbia France Switzerland European Union Northeast Japan California United States South Korea Chinese Subnational Pilots Mexico Tianjin Shenzhen Beijing Chongqing Shanghai Hubei Guangdong

Chile South Africa New Zealand

CARBON TAX implemented or scheduled for implementation

CAP & TRADE implemented or scheduled for implementation

BOTH

4. KEY DESIGN FEATURES or a cap-and-trade program. Two of the most critical choices are the scope of the program and setting the price Establishing a carbon-pricing program requires many or cap levels. This section also discusses the importance design decisions, including which gases and sectors are of reporting and verification, and concludes with an covered, which entities within the relevant sectors are examination of the possible interaction between a carbon- required to comply, and the overall stringency of the pricing program and complementary policies. program. While these elements are described separately below, design decisions require consideration of the inter- 4.1. Scope actions among these elements. Scope refers to the share of total greenhouse gas emissions covered by the program. One element of scope involves The policymakers involved with these decisions will also the greenhouse gases to be included—just CO , or other need to balance various criteria that can sometimes con- 2 gases such as methane and hydrofluorocarbons (HFCs) as flict. These range from comprehensive coverage of emis- well? The second element is which sectors of the economy sions, administrative ease in implementation, minimizing are covered. Several existing programs only cover one sec- the economic costs and maximizing benefits, addressing tor, such as the RGGI program in the northeastern United differing impacts across population groups and regions, States that only includes electricity generation, while oth- and achieving other goals, possibly unrelated to climate. ers are multi-sector, such as California and the EU ETS. The third element is the point of regulation—where and This section highlights some of the main choices facing how emissions from different sectors are covered. This policymakers who are considering either a carbon tax might be “upstream,” using fuels as a proxy for the emis-

WORKING PAPER | April 2015 | 17 Figure 4 | Greenhouse Gas Emissions by Gas in the Figure 5 | Greenhouse Gas Emissions by Sector in the United States, 2012 United States, 2012

Fluorinated Gases (HFCs, PFCs, SF6) 3% Agriculture 10% Nitrous Oxide (N20) 6% Commercial & Residential Methane (CH4) 9% 10% Carbon Dioxide (C0 ) – Non-Energy 5% 2 Electricity 32%

Industry 20%

Carbon Dioxide (C02) – Energy 78% Transportation 28%

Source: Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990–2012. Source: Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990–2012. U.S. Environmental Protection Agency, April 2014. Accessible at: U.S. Environmental Protection Agency, April 2014. Accessible at: http://epa.gov/climatechange/ghgemissions/usinventoryreport.html http://epa.gov/climatechange/ghgemissions/usinventoryreport.html sions that result from fuel combustion, “downstream” at some carbon-pricing systems focus only on this gas. point sources of emissions, or somewhere in between. The Many of the most important sources of CO2, especially final element is whether and how to address imports and those based on fossil fuel combustion, are also generally exports in the program. easy to measure or estimate, making them well suited for inclusion in a carbon pricing system. As seen in Figure 4,

For any carbon-pricing program, the broader the scope, a program that included only energy-related CO2 would the greater the emission reductions that will be expected have covered 77 percent of total U.S. emissions in 2012. from a given carbon price, since more emissions will be covered. A broader scope for a cap-and-trade program Other gases can be included in the system, allowing also means that a greater variety of sources will fall under coverage of a larger portion of an economy’s GHG emis- the cap, leading to lower overall compliance costs because sions. Including these gases requires careful consideration there will be more low-cost emission reduction opportuni- of their relative contributions to climate change. These ties covered by the program. contributions are typically based on the “global warming

potential” (GWP), which compares gases in terms of CO2- 40 4.1.1. Which Gases to Include equivalent (CO2e) units. These estimates can be made based on considerations of the heat-trapping properties of Decisions over which greenhouse gases to include in a the gases and the time the gas remains in the atmosphere. carbon pricing program involve trade-offs between the GWPs have been regularly updated in recent decades, comprehensiveness of the program (that is, the fraction of which can complicate the design of a pricing program. total GHGs covered) and the ease of implementation (the ability to quantify the emissions being taxed or capped The ease of implementing the program is in large part through direct measurement or accurate estimation). For contingent upon the extent to which the emissions can each gas, two key factors to consider are (1) the contribu- be readily quantified or accurately estimated. In some tion of the gas to total greenhouse gas emissions; and (2) cases, proxy measures, such as the carbon content of fossil how difficult it would be to measure and regulate the gas. fuels, provide a solid basis for quantifying the ultimate CO emissions. On the other hand, methane and N O are CO is the most important greenhouse gas (GHG), repre- 2 2 2 second and third in terms of greenhouse gases emissions senting over 70 percent of total GHG emissions globally in the United States, but quantifying or accurately estimat- and over 80 percent in the United States.39 Other key ing methane and N O emissions from agricultural sources greenhouse gases include methane, nitrous oxide, hydro- 2 is difficult, so those sources are less likely to be included in fluorocarbons, perfluorocarbons, sulfur hexafluoride, and a carbon-pricing program. nitrogen trifluoride. Because CO2 is the primary GHG,

18 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

For each gas, policymakers must determine whether the would miss a significant portion of overall emissions. An benefits of the incremental emissions reductions are worth alternative approach, included in many proposals, is to

the difficulties associated with including the gas in the limit the program’s scope to energy-related CO2 emissions, program. which can readily be covered through assigning responsi- bility for emissions to the point in the supply chain where Agriculture 10% 4.1.2. Choice of Sectors the fuels that will result in the emissions first enter the Commercial & Residential 10% economy. A key determinant of the portion of an economy’s green- Electricity 32% house gases that is covered by a carbon-pricing system is There will be different advantages and disadvantages to the choice of economic sectors to be included. One trade- Industry inclusion of other sectors in a carbon-pricing system, and 20% off is between the ability to quantify emissions—whether political considerations will also come into play in decid- directly or through proxy measures such as the carbon ing which sectors to include. A carbon-pricing program Transportation 28% content of fossil fuels—and comprehensiveness. For could also begin with a limited scope and expand to example, the electricity-generating sector already reports include a more comprehensive set of sectors or gases after its GHG emissions.41 As shown in Figure 5, the electric sec- the program is initially established. Table 2 summarizes tor in the United States is responsible for about one third the key aspects of different sectors that affect their inclu- of total GHG emissions.42 Limiting a system to this sector sion in a carbon-pricing system.

Table 2 | Characteristics Relevant for Decisions on Inclusion in a Carbon Price System

SECTOR

Energy CO Readily addressed based on carbon content of fuels and applying the program upstream, where fuels enter the economy 2 ▪▪ ▪▪ Would not require direct emissions reporting from individual sources in different sectors ▪▪ Would cover 78 percent of total emissions in the United States

Electricity Easily identified emission sources that are already subject to environmental regulations and GHG reporting Generation ▪▪

Industry ▪▪ Many emission sources are large facilities that already report GHG combustion and process emissions Numerous smaller industrial sources may be difficult to track and monitor, so might be better addressed through more ▪▪ upstream approaches

Transportation Significant emissions from many small and difficult-to-measure sources so program might be better directed upstream ▪▪ where transportation fuels are produced or distributed

Residential/ Significant emissions from many small and difficult-to-measure sources so program might be better directed upstream commercial ▪▪ where relevant fuels are produced or distributed (or through complementary policies)

Forestry/ ▪▪ Significant source of emissions and potential source of sequestration agriculture Many emission sources and carbon sinks are dispersed and difficult to monitor, so proxy measures might be needed to ▪▪ estimate net emissions

Non-CO gases Some non-CO GHGs are significant source of emissions in some industries 2 ▪▪ 2 Many emissions result from a large number of sources that may be difficult to monitor, so might be better directed up- ▪▪ stream (that is, where the gas first enters the economy)

WORKING PAPER | April 2015 | 19 4.1.3. Point of Regulation The decisions of whether and how to set thresholds are generally based on what proportion of total emissions Different approaches can be taken to allocating respon- are associated with “large” emitters, and these decisions sibility for paying the tax or surrendering allowances. will differ by sector. In many sectors, such as electricity At one end of the spectrum is an upstream approach in generation or cement manufacturing, the most significant which responsibility for the emissions is applied when the emitters will also be responsible for the great majority of materials that will result in the emissions first enter the emissions and will already be reporting emissions. In this economy. In the case of energy-related CO emissions, this 2 case, including all facilities in a carbon-pricing program means that responsibility is applied to energy producers: would greatly increase the number of facilities covered— the entities that mine coal, produce gas and oil, or import including many that are below emission thresholds for fuels. CO emissions from each ton of coal, barrel of oil, or 2 reporting requirements—without significantly increasing cubic foot of natural gas can be readily estimated because the amount of emissions included in the program. Other one molecule of CO results from every atom of carbon in 2 industries, like food processing or pulp and paper, have the fuel (generally speaking). The cost added to the fossil more small- and medium-sized facilities and companies, fuel will generally be passed along to the end users of indicating that lower emissions thresholds for inclusion the energy and, for manufacturers, will be incorporated (or no thresholds) might be appropriate. into production costs. This approach allows a very large fraction of energy-related CO emissions to be covered in 2 Regulating fuels as they enter the economy is one way to a system that requires relatively few responsible parties to address emissions from smaller sources without attempt- play a direct role. ing to regulate them directly. However, even an upstream system will require consideration of whether and how to At the other end of the spectrum, a downstream approach apply thresholds. would apply responsibility at the point where the emis- sions actually occur. Large point sources like power 4.1.4. Imports and Exports plants and steel manufacturing plants are major emit- ters of CO2 because they burn large quantities of fossil A pricing program might also attempt to address emis- fuels. Tapping them as the point of regulation captures sions associated with imports from countries that do not the major emitters who are responsible for a very large have a carbon price in place (or have a lower carbon price) fraction of energy-related CO2 emissions. This approach to avoid putting U.S. producers and manufacturers at an may provide a useful point of regulation for a program unfair disadvantage. The benefits and controversy sur- like RGGI, which is limited to the electricity-generating rounding such “border tax adjustments” are discussed in sector. However, following this path is more difficult for more detail in Section 6.2.3. distributed sources such as residential and commercial building heating systems or cars and trucks. In these For energy imports in an upstream carbon price system, cases, an intermediate point may be more appropriate. applying a border tax adjustment is relatively straightfor- For example, emissions from combustion of natural gas in ward, because the carbon price can be applied at the point household and small-scale commercial use can be cap- of import and a credit can be applied at the point of export tured by making gas utilities responsible for the emissions of domestically produced energy. embedded in their product. A system can include a mix of these approaches. For example, California’s cap-and-trade Addressing emissions associated with imported goods program initially covered large industrial sources directly outside the energy sector is more complicated. “Embed- (downstream), but has since expanded to include distrib- ded emissions,” that is, the emissions generated during uted use of natural gas by homes and smaller businesses manufacture and transport, are a significant concern for through the utility distribution companies (midstream). energy-intensive, trade-exposed industries. The industries that might potentially be affected are an important part In a downstream program, it might be simpler to estab- of the U.S. manufacturing base, but represent a relatively lish an emissions threshold below which sources are not small portion of the U.S. economy.43 See Section 6.2.3 for included. Policymakers must decide whether the expected a discussion of the impact of carbon pricing on industrial emissions reductions from sources with emissions below competitiveness. the threshold are sufficient to make the costs associated with regulating these smaller sources worthwhile.

20 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

As more carbon-pricing programs are established around into the future. These impacts, which affect public health, the world, this issue may recede in importance, but for the environment, and infrastructure, must be translated now it remains one of the potential political concerns that into monetary terms and discounted to present values must be understood when designing any carbon-pricing in order to determine the “cost” of the incremental ton program in the United States. of emissions in today’s dollars. In the United States, the Office of Management and Budget has directed agencies 4.2. Setting the Price or Cap to use a range of SCC estimates in quantifying the benefits of reducing carbon emissions as part of their regulatory Different approaches can be taken to setting the level of a impact analyses. However, the resulting SCC estimates are carbon tax or emissions cap. From a climate perspective, highly imprecise, due to the major uncertainties surround- one can start from either consideration of emission targets ing the impact estimates, and also incomplete, because or estimates of the damages caused by GHG emissions. sufficient information to translate certain damages into For those whose primary interests lie in non-climate monetary values is lacking.45 policy priorities, such as tax reform, setting the price might have more to do with the amount of revenue needed For policymakers who are not motivated primarily by the to serve those priorities. In designing a pricing program, need to address climate change, the amount of revenue it is also important to recognize that the price or cap is needed for particular policy purposes, such as paying for normally not going to be a single number but rather a reductions in payroll or corporate tax rates or provid- trajectory—an increasing tax rate or declining cap over a ing funding for infrastructure, provides an alternative period of years or decades. In any case, setting the level approach for determining the level of the carbon price. of the tax or cap will likely require balancing a variety of Getting the level of the price and its trajectory over time political and economic considerations, such as attempting right would still require modeling; while the price could be to ease the economic transition by starting at a relatively set with certainty for a carbon tax, the effect of the price low price but allowing the price to increase over time to on future emissions, and thus on future revenues, would ensure significant emission reductions. need to be modeled. In addition, if the emissions levels were to fall more quickly than the price were to rise over The United States has put forward emissions targets for time, the result would be declining revenues. Net govern- 2020 (17 percent reduction from 2005 levels) and 2025 ment revenue would also be affected in either type of (26 to 28 percent reductions from 2005). These goals program by the extent to which tax payments or allowance could provide the basis for the trajectory of emissions purchases were deductible business expenses. caps, and modeling could be used to estimate the result- ing carbon price or to suggest an appropriate carbon tax 4.2.1. Changes in the Carbon Price over Time trajectory. Longer-term targets, for example for 2030 or 2050, could be used as well. However, translating between Typically, the program will include an increasing price or carbon prices and emissions levels over the long term— declining cap that changes over time. With a price that whether determining the emissions effects over time of starts at a relatively low level and increases in a predict- a given carbon-tax system or the prices that would result able way over time, the immediate economic effects of the from a given carbon cap—is complicated by the uncer- policy on existing activities are muted, because industries tainties involved in modeling long-term developments in and consumers can adjust gradually to the carbon price. economic and energy systems. (See text box “The Limits of The signal sent throughout the economy—continued Economic Modeling” in Section 6.) emissions will be increasingly costly in future years—is clear and can shift investment and other economic activity In theory, setting a carbon price based on damages caused that need to take into account future costs and revenue by climate change aims to ensure that the full costs of streams. For example, when British Columbia introduced climate change are incorporated into the prices of carbon- its carbon tax, it established the tax at C$10 per ton CO2e intensive goods and services. The United States and other for the first year (2008), increasing at C$5 per year until 46 countries have estimated the “social cost of carbon” (SCC) it reached C$30 in 2012. A decreasing cap works in the to gain insight into a key economic question–what dam- same way, though with uncertainty over the future prices age does an incremental ton of emissions create?44 The that companies and consumers will face. SCC attempts to identify and quantify the major impacts of climate change from around the globe and for centuries

WORKING PAPER | April 2015 | 21 In establishing a carbon-price trajectory, policymakers OFFSETS will need to balance the competing objectives of maximiz- Offsets are documented emissions reductions that occur ing emissions reductions (accomplished with a faster rise outside the regulated sectors, and can be used by regu- in prices) and tempering the near-term economic effects lated entities in lieu of reducing emissions covered by the of the program (accomplished with a more gradually system. Offsets can reduce program costs (because a regu- increasing price). lated entity will utilize offsets when they are less expensive than covered emissions reductions) while achieving the In addition, emission reductions may prove either more same level of emissions reductions. or less expensive than anticipated, with the result that the economic and environmental outcomes differ from Offsets can also provide a way to bring into the program predictions. For example, in the case of both the EU ETS sources that are difficult to address directly. For example, (after its initial phase) and RGGI, shifting levels of eco- overall emissions from agricultural are often difficult to nomic activity and (in the case of RGGI) reduced natural quantify, but it might be easier to quantify (and verify) gas prices meant that the emission levels have been below the emissions reductions from specific actions, such the caps. The EU ETS and RGGI have since moved either as improved manure management. Offsets have been to lower their caps in future phases or delay the auction- included in most cap-and-trade programs, but they ing of allowances to address the unanticipated low level of have often been controversial because of concerns about 47 emissions. Conversely, if emission reductions are more whether the offsets really represent emissions reduc- expensive or otherwise more difficult to achieve, a tax tions that would not have happened anyway.49 Accurately might result in fewer emission reductions than expected or measuring, reporting, and ensuring the quality of offsets a cap-and-trade program might experience higher allow- is essential. They must result from actions that would not ance prices. Unanticipated circumstances can also lead to have been taken without the ability to sell the offset cred- very high prices in a cap-and-trade program or minimal its, and the emissions reductions must be real, permanent, 48 emission reductions resulting from a carbon tax. quantifiable, and verified.50 The decision as to whether to include offsets typically involves weighing the trade- Anticipating such circumstances argues for including an off between lower compliance costs and the certainty of adjustment mechanism in the original program design to achieving the environmental objectives. Including offsets minimize the potential for disruptive, unplanned changes undermines certainty when there are concerns over the or a cost-containment mechanism (see below). In terms validity of the associated emissions reductions. of an adjustment mechanism, for example, the program rules might call for monitoring progress and determining Offsets are more often associated with cap-and-trade whether the price/cap trajectory needs to be adjusted at programs than with carbon taxes, but they can be incor- established points along the way. porated into either type of program. Under cap-and-trade, the offset credits can be used to cover emissions in the 4.2.2. Cost-Containment Mechanisms same way as allowances. Under a carbon tax, regulated Price stability provides an important measure of con- entities can be allowed to use offsets to reduce the quan- fidence for those investing in emission reductions and tity of emissions (or amount of fuel or other proxy for clean technology. In the case of a carbon tax, this is an emissions) on which the tax is assessed. In either case, the inherent aspect of the program—the design establishes the system would need to include rules for establishing defini- price of carbon emissions over time. Cost-containment tions of valid offsets and limits, if any, on their use. mechanisms can address concerns regarding severe price fluctuations in a cap-and-trade program. If prices rise too PRICE CEILINGS AND FLOORS high or too quickly, they could result in significant eco- A price ceiling limits how high (or how fast) allowance nomic harm; if they drop too low, they will not provide the prices can rise, and a price floor limits how low they can desired price signal for low-carbon investment. As with fall. Used together, they form a price collar. These mecha- most program design choices, the decisions as to whether nisms are relevant only for cap-and-trade programs, and to include cost containment mechanisms typically involve make those programs more like a carbon tax by increasing trade-offs, which are discussed below for offsets and price certainty about future prices. For example, the Califor- ceilings/floor. nia cap-and-trade program includes a price floor that is

22 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

implemented as a minimum price on the auction of its and verification that is accurate and reliable while also allowances. The floor was initially set at $10 per ton of minimizing administrative and regulatory burdens to the

CO2e, increasing annually at the rate of inflation plus five extent possible. percent. 4.4. Complementary Policies A program might include a ceiling, a floor, or both. The A price on carbon can be a key element of a broader purpose of the ceiling is to prevent economic disruption climate policy because it provides significant signals from very high carbon prices or from prices that rise too throughout the economy that encourage a shift to lower quickly. In general, a price ceiling will result in higher carbon energy and products. However, additional pro- emissions over time, since the primary response to hitting grams and policies will likely be needed to help provide the ceiling is likely to be an increase in the supply of allow- a cost-effective path to deep greenhouse gas emissions ances. A price floor can be used to prevent the collapse of reduction in the coming decades. the carbon price, ensuring that clean energy investments will at least be supported by a known minimum carbon 4.4.1. Addressing Emissions and Sources price. Outside the Program Scope

The drawback of price ceilings and floors is that they cre- A carbon-pricing program is unlikely to address all ate inefficiencies in the markets for emissions allowances. sources of greenhouse gas emissions, because some Buyers and sellers might both wish to trade at a price emissions are too dispersed or hard to measure to be higher than the ceiling or lower than the floor, but they are included in a program without overburdening administra- prohibited from doing so. Policymakers must determine tion. To reduce greenhouse gas emissions throughout the whether the benefits noted above are worth the costs of economy, additional approaches can encourage or require these market inefficiencies. emission reductions from sources not covered by the car- bon price. Such approaches might include offset programs 4.3. Reporting and Verification allowing crediting of emission reduction activities, direct regulation, investments in R&D, or incentive programs. A key prerequisite for a successful system is a robust reporting and verification system. Such a system needs to 4.4.2. Energy Efficiency be appropriate to the point of implementation; it is critical Energy efficiency has many well documented market bar- to have accurate and verified reporting of the emissions riers, such as split incentives between building owners and tied to the entity in the system that is responsible for tenants, up-front costs, and lack of information, which them. An upstream approach involves reporting the pro- hamper the achievement of the full range of cost-effective duction and imports of fossil fuels (often already done for opportunities.52 Applying a carbon price will strengthen other purposes) and translating the fuel report data into the market signals and provide incentives for additional equivalent emissions. Similarly, downstream or interme- energy efficiency, but will not eliminate market barriers. diate approaches mean that reporting must accurately tie For this reason, many programs that currently provide the emissions to the responsible entity. incentives to efficiency might still be needed, even with a carbon-pricing system in place. Carbon revenues, how- Because the addition of a carbon price creates direct ever, could provide significant additional funding to help economic consequences, verification of entities’ emission support or expand such programs over time; this has been reports is essential. Different approaches to verification the case with the RGGI program. The Analysis Group has are possible, from independent third party verification to shown that, in the first three years of RGGI’s operation, self-certification with strong penalties. To provide con- RGGI added $1.6 billion in net present value to the econo- fidence that those covered by the program are providing mies of the participating states, in large measure thanks to consistent and accurate information, the reporting must spending auction revenues on energy efficiency programs.53 be complete, accurate, consistent, transparent, and with- out material misstatement.51 Piggy-backing on existing reporting systems to the fullest extent possible simplifies 4.4.3. Regulations and Standards implementation for both business and the government. Market mechanisms such as a carbon tax or cap-and- In designing a carbon-pricing program, policymakers trade program are often considered more cost effective must determine how to develop a system for reporting in achieving emission reductions than more traditional

WORKING PAPER | April 2015 | 23 regulations and standards, assuming that relevant mar- the grid, because any benefit from increased distributed kets (especially for energy efficiency and innovation) are power generation does not tend to accrue to parties invest- functioning close to the competitive ideal.54 For policy- ing in the grid. Public investment in infrastructure and makers who view a carbon price as a means to other policy enabling technologies might be able to unlock significant goals, avoiding these types of regulations and standards emission reduction opportunities across the economy. might be seen as a goal of implementing a carbon price. 4.4.5. Research and Development However, in certain circumstances, a carbon price might Achieving the deep emission reductions needed by mid- be less effective at reducing greenhouse gas emissions century will require significant technological innovation than alternative policies; markets are not perfect, and and advancement. Increased support for research and in some cases prices will not be effective. For example, development is likely to speed the development and even a low carbon price applied uniformly across the U.S. deployment of new and improved technologies that may economy would likely achieve significant power sector significantly reduce the cost of achieving the long-term reductions, where significant low-cost opportunities are emission goals. See Section 5.3.2, below, for further available, but a higher carbon price would be required to discussion on using revenues from a carbon-pricing have meaningful effects in the transportation sector. The program to support innovation in emissions-reduction relatively low rate of fleet turnover slows the rate at which technologies. changes in vehicle technology lead to emission reductions, and shifting from gasoline and diesel to lower carbon fuels will require both vehicle and fueling infrastructure changes. Given that vehicle technology, fueling infrastruc- 5. COMMONLY PROPOSED USES OF ture and purchase patterns have little near-term response to a carbon price, pairing a carbon price with continued CARBON PRICING REVENUES strong vehicle and alternative fuel standards is likely According to the Environmental Protection Agency, U.S. to prove a more effective approach to achieving deeper greenhouse gas emissions in 2012 were more than 6.5 bil- medium-term emission reductions, with the added benefit lion metric tons of carbon dioxide equivalents.55 A carbon of reducing reliance on oil imports. tax, or a cap-and-trade program with allowance auctions, therefore has the potential to raise well over $100 billion Similarly, a major near-term response to a carbon price per year at a moderate price of about $15 per ton, depend- in the electricity sector in the United States would likely ing on its initial level and scope (for reference, in 2013 the be the increased use of natural gas. This could provide corporate income tax brought in roughly $273 billion of significant emission reductions for the next decade, but if revenue).56 In an economy with a gross domestic product deeper reductions are desired in the medium to long term, of nearly $17 trillion, this is a relatively small but far from a continued shift to use of zero- and near-zero emissions negligible sum.57 For a Congress looking for new sources sources, for example, renewables, nuclear power, and of revenue to finance tax reform or avoid cutting politically coal plus carbon capture and sequestration, is likely to be popular tax expenditures, a carbon price could receive needed. Continued support through standards and other some unlikely support—potentially even from those who policies for these technologies might be a means to achiev- are not focused on reducing GHG emissions, but who see ing such medium- to long-term emission reductions. a carbon tax as more palatable than other taxes or as a potential substitute for regulations. 4.4.4. Investing in Enabling Technologies How any revenue gets spent will, of course, be decided by Many emission reduction opportunities depend on other the legislative process. Yet, because it is one of the most technologies that are not likely to be stimulated by a car- critical and politically contentious elements of carbon- bon price because of the same market barriers that ham- pricing policy design, with implications for individuals, per energy efficiency investments. For example, technical companies, and the economy, this paper examines some of upgrades to the national grid would enable an increased the most commonly proposed uses of revenue. contribution of power from distributed electricity generat- ing sources, including renewables. A carbon price by itself Policymakers have no shortage of competing priorities is unlikely to provide sufficient incentive for investment in from which to choose, and each presents a wide range of

24 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

advantages and disadvantages. Many revenue uses could these revenue uses by their primary intended effect but, as potentially provide a “double dividend” of reduced green- illustrated in Table 3 below, spending revenue can have a house gas emissions and improved economic efficiency. wide array of economic impacts. Indeed, previous analysis by WRI and others indicates that well-designed policies to combat climate change can 5.1. Encourage Economic Growth enhance economic growth.58 5.1.1. Reduce Distortionary Taxes While the prospect of significant new revenue can bring Economists typically single out several categories of taxes many people to the table for a conversation, disagree- —such as those on labor, investment, and capital—as being ments over how to slice the pie can make the resulting “distortionary;” that is, they serve to discourage things like discussions difficult. For example, some proponents59 of work and investment, which are encouraged elsewhere a carbon tax insist on a revenue-neutral offsetting of the in the tax code and by other policies. Using some or all of carbon tax with an attendant reduction in other taxes, the revenue from a carbon tax to reduce these distortion- while others60 advocate for returning revenues to house- ary taxes, including payroll and corporate and personal holds, reducing the deficit, or spending the money on income taxes, can result in increased economic growth other priorities. and output.

Different stakeholders have differing views of revenue Economists from across the political spectrum are among neutrality. Many conservatives would consider a carbon those most keen to use carbon tax revenue to offset dis- tax to be revenue neutral only if all revenues were used to tortionary taxes elsewhere.63 Doing so, they argue, would reduce other taxes, with the federal government seeing no make the tax code more efficient, and would reduce disin- net increase in tax revenues, and no new spending.61 Pro- centives to work and invest. Among the taxes most cited as ponents of a fee-and-dividend policy, on the other hand, ripe for reduction are payroll taxes and those on corporate view their approach as revenue neutral as well, in that all income. The former are more regressive than the tax code carbon-tax revenues are returned to households rather as a whole—in 2014, only the first $117,000 of income was than used by the government for other purposes.62 subject to Social Security payroll taxes—and they increase the cost of labor, discouraging employers from additional In this section, we’ll review many of the most commonly hiring and reducing the incentive to work. Taxes on corpo- suggested uses of revenues from a carbon tax or allowance rate income are passed through to customers, employees, auctions under cap-and-trade, including: or shareholders, and are an inefficient means of taxing any of these groups. They can also discourage companies from ▪▪ Reducing “distortionary” taxes such as payroll, investing and establishing or keeping their operations corporate and personal income taxes; in the United States, which nominally has the highest mar- ginal corporate income tax rate in the developed world.64 Reducing government deficits; ▪▪ However, the effective tax rate—what companies actually Investing in job training; pay—is typically far less than this statutory rate, for a ▪▪ variety of reasons.65 Using carbon-tax revenue to reduce Returning the revenue to households or electricity either, or both, of these taxes can pay dividends through- ▪▪ consumers; out the economy, including greater economic growth and increases in overall employment. ▪▪ Addressing regional disparities; Investing in economic competitiveness; Such a “revenue-neutral tax swap” is among the most ▪▪ common policy proposals from advocates of carbon taxes. Investing in technologies that enable communities to Typically, in these proposals, most or all of the revenue ▪▪ adapt to climate change; and from the carbon tax goes toward reducing other taxes, so there is no increase or decrease of revenue to the govern- Investing in clean technology innovation. ▪▪ ment. Generally speaking, most studies on the topic have For each alternative, we provide an overview of the found that, while reducing taxes on either labor or capital economic and political strengths and weaknesses, and can offset at least some of the negative effects on economic real world examples, where available. We have grouped output from a carbon tax, reducing the top tax rate on

WORKING PAPER | April 2015 | 25 capital would be most effective at reducing the inefficiency future tax reduction (government deficits can be rolled caused by the tax system. For example, McKibbin et al. over forever, so whether to raise taxes to pay down the (2012) found that implementing a tax on carbon and debt can be as much a policy question as an economic reducing the marginal tax rates on capital would result one). Although the issue of the rising national debt has in greater economic growth in the coming decades than faded somewhat after the deficit peaked in fiscal year 2011, would be the case in a business-as-usual scenario.66 But many policymakers are still weighing the available options the authors found that cutting marginal tax rates on labor for long-term solutions to a potentially destabilizing fiscal instead would result in a small net negative effect on total problem.72 economic output. And Carbone et al. (2012) found that cutting taxes on capital was more beneficial than cutting Ireland implemented a carbon tax in 2010, covering most taxes on labor or consumption from an economic growth of the carbon dioxide emissions from sectors not already standpoint (though with no provision for issues of distri- included in the European Emissions Trading Scheme. butional equity), and this finding applied to both present Following the 2008 fiscal crisis, the decision was made to and future generations.67 institute a carbon tax in lieu of other austerity measures and tax increases, and use much of the revenue to reduce While reducing capital tax rates might be the most effi- annual budget deficits. In the years since its implementa- cient use of revenue, studies have found that reducing tax tion, the carbon tax has contributed to a dramatic slow- rates on labor can offset at least a significant portion, and down in the growth rate of the Irish national debt and has perhaps all, of the potential adverse economic impacts of led to a reduction in emissions from covered sectors.73, 74 the carbon tax. For example, a 2011 OECD study found While the circumstances under which the carbon tax was that when “revenues [from allowance auctions of an first implemented were extraordinary, this case neverthe- emissions-trading program] are used to reduce taxation less illustrates the way in which a carbon tax can help on labor, the pace of employment growth would acceler- address national debt. ate…without any loss of purchasing power for workers.”68 According to Lawrence Goulder, an economics professor 5.2. Ease Transition Costs for Individuals, at Stanford University, the greater the inefficiency in the Sectors, and Regions current tax system, the more likely it is that using carbon- 5.2.1. Invest in Job Training tax revenues to cut labor taxes will lead to an increase in overall employment and economic growth.69 See Section By inducing changes in behavior and purchasing patterns, 6 for more details on the economic effects of reducing a carbon price will, over time, benefit some industries distortionary taxes. (renewable energy, energy efficiency, clean vehicles, etc.) at the expense of others, especially coal and oil 5.1.2. Reduce Deficits production. While such structural shifts in the economy may not significantly affect overall employment, and are a Interest payments on the national debt can potentially regular part of growth and economic shifts, policymakers crowd out other investments, dampening economic may nonetheless decide to enact measures to ensure growth and output. Some economists argue that future those that are adversely affected by a carbon tax are able tax rates will need to increase in order to make interest to transition quickly and find new jobs. Federal support payments and pay down the debt, and that the expectation for job training programs,75 spending on education, and of future tax increases will discourage work and reduce other uses of carbon tax revenues can limit the impact savings.70 Some carbon-tax advocates therefore argue that of a carbon tax on employment in particular industries, policymakers have good incentive to use revenues from or accelerate a transition to clean energy jobs.76 In some the tax to reduce annual deficits and pay down the debt, cases, new initiatives for displaced workers can build upon leading to long-term economic growth.71 (For more discus- existing federal programs.77 sion of the economic impacts of using carbon-tax revenue to reduce the national debt, see Section 6). Some studies have found benefits to both short-term and long-term job training programs. Low-cost, short-term Much like reducing distortionary taxes, proponents of programs—those designed to get a person back to work as using carbon-tax revenue to address the national debt quickly as possible—have been found to reduce the time are trading one tax for another—in this case, offsetting a spent unemployed and increase job stability, and they are potential future tax increase, or allowing for a potential cost effective in the near term. Participants in long-term

26 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Box 5 | British Columbia’s Carbon Tax—Proving training programs, which are aimed at giving workers the Emissions Reductions and Economic skills they need to succeed in a new field, benefit from Growth Can Co-Exist even more job stability and higher lifetime earnings.78 On- the-job training programs have also proven cost effective. A study of 16 trades across the Canadian economy found that employers received C$1.47 in benefits for every C$1 The Canadian province of British Columbia provides a real- invested in apprenticeship programs.79 world example of a carbon tax that reduces other taxes and is intended to be revenue neutral. British Columbia implemented There are few examples of existing carbon-pricing policies a carbon tax of C$10 per metric ton of CO2 equivalent in July 2008, which increased by C$5 per year to C$30 per metric ton that re-invest revenues into job-training programs, but the in 2012; the tax will remain at C$30 per metric ton through recently enacted carbon tax in Chile may prove instruc- 2017. The tax was designed to be revenue neutral, as the tive as it is implemented. In September 2014, as part of province anticipated using the revenues from the carbon tax to a broader tax reform, Chile enacted a $5-per-ton tax on reduce a range of personal and business taxes. Those measures carbon emissions from power plants in order to reduce its include providing a tax credit for low-income households, reducing the two lowest personal income tax bracket rates fossil fuel imports and encourage renewable energy devel- by five percentage points, and cutting the general and small opment. It has been proposed that, when it goes into effect business corporate income tax rates by two percentage points.a in 2018, most of the revenues from the carbon tax, and In its first few years, however, the tax was actually revenue other tax increases, will go toward education initiatives. negative, in part because the price on carbon reduced demand While this policy will not likely pay immediate economic more than anticipated, leading to carbon-tax revenues that were lower than the province had projected. British Columbia dividends, Chile views it as a long-term investment in the therefore took in less money from its carbon tax than it cut from economy and a way to reduce economic inequality. It will other taxes. be a case study to follow in the years to come.80

A 2013 analysis of British Columbia’s carbon tax found that it has been successful in reducing greenhouse gas emissions 5.2.2. Return Money to Households or Electricity without adversely affecting economic growth. In the five years Consumers following implementation, per capita greenhouse gas emis- The notion of sending a quarterly or annual check to sions fell 18.8 percent relative to the rest of Canada, while GDP growth kept pace with the rest of Canada. Moreover, the households to offset the increase in commodity prices province’s personal income tax rates are now the lowest in the resulting from a carbon tax—known as “fee-and-divi- country, and its corporate tax rates are among the lowest in dend”—has grown in popularity in recent years, largely North America.b British Columbia therefore provides an ex- because of its perceived fairness and simplicity. By divid- ample of one way in which governments can reduce distortion- ing carbon-tax revenues equally amongst all consumers, ary taxes, address regressivity, and reduce emissions–all while ensuring that no income group is made worse off. We should programs ensure that lower income households receive note, however, that some observers question British Colum- as much or more in revenue as they spend on the tax, and bia’s suitability as an example for a carbon tax in the United a sizeable fraction of households would be net winners States, especially given the differences in sources of electricity on a monetary basis.81 Unlike proposals to reduce other c generation between the two regions. taxes, fee-and-dividend programs do not have to contend Notes: with the problem of declining carbon-pricing revenues a. British Columbia Ministry of Finance. February, 2012. “Budget and that must still fund permanent tax cuts. Also, by giv- Fiscal Plan, 2012/13-2014/15.” Available at http://www.bcbudget.gov. ing revenues to individuals or groups, policymakers can bc.ca/2012/bfp/2012_Budget_Fiscal_Plan.pdf potentially increase public support for continued carbon b. Elgie, S., and J. McClay. 2013. “BC’s Carbon Tax Shift After Five pricing and make such a policy more “sticky,” because any Years: Results.” Sustainable Prosperity. July. Available at: http://www. sustainableprosperity.ca/dl1026&display reduction in price or repeal of the policy would reduce or 82 c. See, for example, Marlo Lewis, “Why British Columbia’s Carbon Tax is eliminate those dividends. Not Applicable to America,” OnPOINT, September 16, 2014, https://cei. org/sites/default/files/Marlo%20Lewis%20-%20Why%20British%20 However, some commentators do not agree that imple- Columbia’s%20Carbon%20Tax%20Is%20Not%20Applicable%20to%20 America_0.pdf. mentation would be so straightforward. Many also dis- agree with the characterization of this as a revenue-neutral option. Providing dividend checks would likely involve at least a small amount of new spending and growth of gov- ernment to determine and distribute the dividends. Fur-

WORKING PAPER | April 2015 | 27 Figure 6 |  Primary Home Heating Fuel, by Census Division

100% Other/none

Fuel Oil & Kerosene

LPG

Natural Gas

Electricity

0% 2005 2013 2005 2013 2005 2013 2005 2013 2005 2013 Northeast Midwest South West United States

Source: “Everywhere but Northeast, Fewer Homes Choose Natural Gas as Heating Fuel,” U.S. Energy Information Administration, September 25, 2014, http://www.eia.gov/todayinenergy/detail.cfm?id=18131. thermore, a policy that provides equal dividends to every programs. The Alaska Permanent Fund returns a portion individual could support the perception that a carbon tax of that state’s oil revenues to its citizens every year. would affect some states and regions more than others, And California is recycling some of the revenue from its though these regional disparities may be overstated (see allowance auctions back to households in the form of additional discussion in Sections 5.2.3 and 6.2.2). semi-annual rebates on electricity bills, administered by the investor-owned utilities (IOUs) in the state, as directed Various methods can be used to administer rebate checks by the California Public Utilities Commission. The revenue in a fee-and-dividend program. Existing federal pro- for the rebates comes from a reverse auction of allowances grams that disburse money, such as Social Security or the that were distributed to investor-owned utilities under the Temporary Assistance for Needy Families program, can cap-and-trade program rules. supplement households’ monthly checks with carbon-tax revenues. For non-participants in those programs, the 5.2.3. Address Regional Disparities government can send a monthly check, or give annual tax Some regions in the United States are more heavily refunds. All of these means of returning revenues carry dependent on the production or consumption of fossil various administrative burdens and costs. fuels than others, and so will be differently affected by the implementation of a carbon price. A reduction in demand Several examples of redistributing revenues to households for coal, for example, could have adverse impacts on the may be instructive to policymakers. In 2008, Switzerland coal-producing regions of Wyoming, West Virginia, and implemented a carbon tax on hydrocarbon fuels, which Kentucky, among other states.84 Residents of states that applies to all individuals and those companies that do get most of their electricity from coal would likely see their not participate in the national cap-and-trade program. monthly electric bills increase in the near term. Many Revenues are redistributed to taxpayers in the form of households in the Northeast, heavily reliant on heating oil, lower health insurance premiums for individuals, and would see wintertime energy costs increase.85 are returned to companies based on their total payroll. While few studies have analyzed the economic impacts However, recent analysis suggests that regional dispari- of Switzerland’s carbon tax, since its implementation in ties in the consumption of carbon-intensive goods are not 2008 Switzerland has kept pace with, or exceeded, other as great as once feared.86 Regions that are more heavily developed countries in a variety of economic indicators.83 dependent on one fossil fuel tend to be relatively less dependent on others—for example, while the Northeastern In the United States, there is precedent for recycling states burn more oil for home heating, their electricity mix revenues to households, though as part of very different is relatively less dependent on coal (see Figures 6 and 7).87

28 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Figure 7 |  Electricity Generation Fuel Mix, by Region

1% <1% <1% 3% 2% <1%

14% 7%

38% PACIFIC 22% EAST SOUTH 46% CONTIGUOUS CENTRAL

36%

7% 23%

1% <1% 2% <1% 2% 1%

7% 8% 26% 8% 54% 36% MOUNTAIN SOUTH ATLANTIC

22% 33%

<1% <1% <1% 3% 1%

6% 14% 23% 3%

12% WEST NORTH MIDDLE CENTRAL ATLANTIC 67% 37% 5% 30%

1% 3% 1% 1% 1% 5% 8% 7% 7% 10% 35% WEST SOUTH NEW CENTRAL ENGLAND 45% 32% 45%

<1% 3% <1% 1% 4% 12%

25% EAST NORTH PACIFIC NON- 21% 48% CENTRAL 60% CONTIGUOUS

9% 9% 7%

Coal Natural Gas Nuclear Hydro Other Renewables* Fuel Oil Other

*Includes generation by agricultural waste, landfill gas recovery, municipal solid waste, wood, geothermal, nonwood waste, wind, and solar. Source: “Different Regions of the Country Use Different Fuel Mixes to Generate Electricity,” Edison Electric Institute, August 2014, http://www.eei.org/issuesandpolicy/generation/fueldiversity/Documents/map_fuel_diversity.pdf.

WORKING PAPER | April 2015 | 29 As Tufts University Economics Professor Gilbert Metcalf stringency of a suite of climate policies in other countries. has found, returning carbon-pricing revenues to house- Further discussion on border adjustments can be found in holds via payroll tax reductions and Social Security can all Section 6.2.3. We should also note that many of the United but eliminate regional disparities while making all regions States’ largest trading partners already have carbon-pric- better off.88 ing policies in place. See Appendix A for more details.89

Nevertheless, such concerns were a major sticking point Of course, some portion of carbon-tax revenues can be in the debate surrounding how to apportion allowance returned to energy-intensive trade-exposed industries, as revenue under the American Clean Energy and Security a means of sustaining international competitiveness (and Act (ACES). To mitigate against increases in energy prices if the corporate income tax rate is cut as part of a carbon- that would affect some regions more than others, the bill’s tax swap, many of these companies will already receive authors devoted some allowance revenue to electricity a tax break). As long as the revenue is not returned to and natural gas local distribution companies, as well as these industries on the basis of their emissions, the price state programs that support home heating. The notion signal to encourage companies to reduce their emissions that some regions would be more adversely affected than will remain. However, returning revenues to energy- others will likely be a contentious issue in any political intensive trade-exposed industries does not provide a way debate surrounding a carbon price. This issue is discussed to address the fact that some other jurisdictions already in more detail in Section 6, below. apply a carbon price.

5.2.4. Invest in Economic Competitiveness Denmark instituted a carbon tax in 1992 and, since 1995, has been returning a portion of revenues to various indus- Many industries, especially manufacturing, rely heavily on tries. In order to advance the goal of changing industrial energy derived from fossil fuels as a primary input. There behavior in order to reduce greenhouse gas emissions, the is concern that, if a price on carbon results in the prices Danish government also provides a 25 percent reduction of those fuels increasing to the point that it is cheaper for in a company’s tax burden if it signs an agreement to take companies to relocate their operations elsewhere, some steps to reduce its energy use. The Danish carbon tax has manufacturing jobs could be lost. While recent studies proven effective at reducing emissions, especially from suggest that this may be less of a problem than previously industry. Industrial emissions fell 23 percent in the decade thought (see Section 6.4), many advocates of a national following the implementation of the carbon tax, and per climate policy call for measures to ensure that American capita emissions in Denmark declined 15 percent between industry remains competitive in the global marketplace. In 1990 and 2005.90 a cap-and-trade program, this can be achieved by distrib- uting free allowances to industries identified as vulner- able to competitive pressures because of the carbon price Wind projects in Denmark also receive revenues from (often called energy-intensive trade-exposed industries). the country’s carbon tax, which has helped the country become a global leader in wind power. Denmark is home to the wind turbine manufacturing operations of Vestas Under a carbon tax, the most frequently discussed cor- and Siemens, which together have nearly 20 percent of responding policy tool is a border adjustment, whereby global market share,91 and nearly 40 percent of Danish imports from countries without equivalent policies are electricity consumption in 2014 came from wind power, assessed a tariff based on the carbon content of their the highest figure in the world.92 goods, and exports given a rebate of the tax paid in the manufacture of the good. If the trading partner has a 5.3. Support Related Goals climate policy in place that implicitly or explicitly prices carbon emissions equivalently to the U.S. domestic carbon 5.3.1. Respond to Climate Change tax, the border adjustment can be waived. If the trading Some proponents of carbon pricing believe that revenue partner has a climate policy that is less stringent than would be best spent on infrastructure that helps make that of the United States, the border adjustment can be communities more resilient to the impacts of climate reduced accordingly. This creates difficult questions for change.93 Such investments can serve a variety of pur- regulators, such as how to quantify the effect of regula- poses, including: tions that reduce emissions and how to determine the

30 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Increasing the resiliency of water, transport, energy, can stimulate innovation. Alone or in conjunction with ▪▪ and other forms of infrastructure that are vulnerable complementary policies (as discussed in Section 4.4), to extreme weather and other effects of a changing a carbon price encourages companies to develop new, climate cleaner, more cost-effective technologies and processes. As the Organisation for Economic Co-operation and Develop- Reducing emissions and improving the resiliency of ment has written: ▪▪ the electric grid by building out renewable energy and distributed generation infrastructure, and expanding “…environmentally related taxes can provide signifi- smart grids cant incentives for innovation, as firms and consum- ers seek new, cleaner solutions in response to the ▪▪ Creating jobs through the spending of public money price put on pollution. These incentives also make it on needed investments in adaptation and resilience commercially attractive to invest in R&D activities to develop technologies and consumer products with a Spending some carbon-tax revenues on adaptation allows lighter environmental footprint, either by the polluter for a carbon tax to address both the causes and effects of or by a third-party innovator… Even for firms that do greenhouse gas emissions simultaneously.94 The World not have the resources or inclination to undertake for- Bank estimates that global investments to adapt to a malised R&D activities, the presence of environmen- changing climate will need to reach $70-100 billion per tally related taxation provides increased incentives to year through 2050—and even more if warming exceeds bring in the latest technologies that have already been two degrees Celsius.95 Estimates of adaptation costs in the developed elsewhere.” 99 United States vary widely, but could reach tens of billions 96 of dollars per year by the middle of the century. It is highly unlikely that a low to moderate carbon tax would achieve the level of emissions reductions the Governments can also choose to spend revenues from a Intergovernmental Panel on Climate Change (IPCC) carbon tax on clean-energy initiatives designed to achieve recommends in order to prevent the worst impacts of additional emissions reductions, and possibly reduce the climate change.100 Therefore, some supporters of a carbon costs of complying with the carbon price. These initiatives tax propose using some revenue to encourage innovation can take the form of investments in renewable energy, in technologies or practices that could help reduce green- demand-side or supply-side energy efficiency, building house gas emissions.101 The federal government already retrofits, or other measures designed to reduce the carbon invests in research and development—the Department of intensity of energy use. Energy supports renewable energy, fossil energy, nuclear energy, and energy efficiency—and those programs have There are precedents for governments investing carbon- paid dividends in the form of technological advancement pricing revenues to help spur additional emissions and lower costs to businesses and consumers.102 But, while reductions, though on a smaller scale. Germany currently we can make significant emissions reductions with tech- devotes all revenues from its allowance auctions to domes- nology available today, in order to achieve much deeper tic and international climate initiatives. These include emissions reductions by mid-century we will need either “innovative projects” in Germany’s industrial sector, other innovative breakthroughs or continuous improvements in energy-saving domestic initiatives, and international the existing suite of technologies, or both. climate finance to help spur emissions reductions in other countries.97 In the United States, RGGI states devoted Devoting some carbon-tax revenue to R&D can potentially over 70 percent of allowance auction revenues to energy help to reduce the long-term costs of complying with the efficiency and renewable energy projects between 2009 tax and reducing emissions, in several ways. First, as and 2012—measures that RGGI estimates will avoid eight reaffirmed in a pair of 2014 reports, both the public and private sectors often underinvest in innovation:103 million tons of CO2 emissions and save consumers more than $2 billion in energy savings.98 “Financing for research and development in the power 5.3.2. Encourage Investment in Clean sector does not match the scale of the challenge [of Technology Innovation reducing emissions]. Power company funds spent on research and development were only $280 million in By changing the relative prices of goods, and creating 2011, or approximately 0.05 percent of power sec- financial incentives to reduce emissions, a price on carbon

WORKING PAPER | April 2015 | 31 Table 3 |  Revenue Options, and the Policy Goals they are Designed to Achieve

POLICY GOAL Additional Correct for Foster Preserve or Reduce Costs Revenue Economic Cut Taxes Emissions Regressivity Create Jobs of Compliance Neutrality Growth Reductions

Reduce Distortionary a Taxes ?

Reduce b Deficits ?

Invest in Job Training

Return Money c e d to Households ? ? ?

Address Regional Disparities REVENUE OPTION Invest in Eco- nomic Competi- tiveness

Respond to Climate Change e Impacts ?

Encourage Investment in Innovation

Notes: a. If payroll or other labor taxes are cut, there could be a small improvement in the overall progressivity of the tax code, which could address income inequality in a modest way. If carbon tax revenues are used to reduce corporate income taxes, any such effect would be muted. b. Depending on whether and how additional revenue is raised from alternative sources. c. Proponents of a fee-and-dividend approach claim that it will foster economic growth, but the economic literature is divided on this. See Section 6 for more detail. d. The revenue neutrality of returning all carbon-tax revenues to households in the form of dividends is in the eye of the beholder. Some proponents, such as Citizens Climate Lobby, believe fee-and-dividend to be revenue neutral (see https://citizensclimatelobby.org/carbon-fee-and-dividend/). Others disagree, pointing to the need to devote some revenues to the administration of the program, and the belief that dividends are a form of government spending and not tax reduction. e. The evidence is mixed as to whether these revenue uses achieve the stated policy goals.

32 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

tor sales. By comparison, company funds spent on auction revenue was needed to ensure that the bottom research and development were 11 percent of sales quintile of the income distribution was not adversely for pharmaceuticals, eight percent for computers and affected by higher energy prices.107 The 2009 ACES Act electronics, five percent for professional services, and followed this guidance and devoted about 15 percent three percent for general manufacturing.” 104 of allowance revenue to lower income households. To achieve a variety of policy goals, the bill’s authors also Government support of research, development, and dem- proposed giving free allowances (or devoting allowance onstration of measures to reduce emissions from energy, revenue) to electricity and natural gas distribution com- transportation, agriculture, or other sectors can fill the panies to protect consumers from higher energy prices, to gap created by private sector underinvestment, and help energy-intensive and trade-exposed industries, to innova- bring down the costs of breakthrough technologies. This, tion and R&D, and for adaptation investments (see Figure in turn, could help to drive more cost-effective emissions 8).108 reductions and reduce the cost of complying with the car- bon tax.105 Polls suggest that public support for a carbon California is currently putting many of those principles tax grows when revenue is used for R&D (though many into practice.109 In addition to the semi-annual rebates polls do not ask respondents what level of tax they would on electricity bills mentioned above, the state is devoting be comfortable with).106 some of its allowance revenue to transportation infrastruc- ture (including high-speed rail and other mass transit), 5.4. Mixing and Matching affordable housing, energy- and water-efficiency projects, Of course, policymakers will likely choose several options support for low-income and minority communities, and 110 for using carbon-price revenues, and divide the money several other smaller programs. While distributing between them. In this way, a carbon-pricing policy can revenues across a variety of end-uses can diminish the achieve (or contribute to achieving) a number of the goals effectiveness in achieving certain policy goals, it may allow outlined in this section. For example, in its analysis of a a federal carbon-pricing program to address multiple pri- federal cap-and-trade program, the Center for Budget and orities. See Table 3 for a summary of how various revenue Policy Priorities found that only 14 percent of allowance options can satisfy one or more policy goals.

Figure 8 | Cumulative Distribution of Allowances Under ACES, 2012-2050

Strategic Reserve 2%

Domestic Fuel Production 1% Other (Early actors, worker transition, deficit reduction)2% Consumers (Electricity, natural gas, home heating, Merchant Coal Generators & Long-term Power 3% low-income, etc.) 58%

Technology (Renewables, Efficiency, CCS, Autos, etc.) Prevention of Tropical Deforestation 4% 15% Energy-Intensive, Trade-Vulnerable Industries 8% Adaptation (Domestic & International) 7%

Source: “Distribution of Allowances Under the American Clean Energy and Security Act (Waxman-Markey),” Pew Center on Global Climate Change, August 2009, http://www.c2es.org/ docUploads/policy-memo-allowance-distribution-under-waxman-markey.pdf.

WORKING PAPER | April 2015 | 33 6. ECONOMIC EFFECTS OF A economy. By using carbon tax revenue to reduce existing tax rates on corporate income, personal income, or payroll CARBON PRICE taxes, policymakers can increase the incentives to work Like other climate and tax policies, pricing carbon will and invest while reducing the incentive to over-consume necessarily have economic impacts. The economic litera- fossil fuels. For example, Parry et al. (2011) find that “if ture on a carbon tax’s effects on economic growth and revenues are used to substitute for distortionary income output, jobs, income, regional disparities, and industrial taxes (either directly or indirectly through deficit reduc- competitiveness is both deep and wide. These studies tion), economy-wide carbon taxes…may have (slightly) 111 can tell us much about how a carbon tax can change an negative costs.” economy as it transitions from being highly dependent on PROVIDING DIVIDENDS. Carbon-tax revenue can also be fossil fuels toward a lower carbon future. recycled to households on a monthly, quarterly, or annual The design choices discussed in Section 4 help to deter- basis, either via a new federal program or through any of mine the economic effects of a given carbon-pricing policy, a number of existing programs; these programs include, among the most consequential decisions for policymakers but are not limited to, Social Security, Supplemental in this regard is how to spend the revenues. Nutritional Assistance Program (SNAP, also called food stamps), or via annual tax returns (further discussion of 6.1. Macroeconomic Impacts federal programs that could be used to return revenues to households can be found in Section 5.2.2). Most 6.1.1. Effects of a Carbon Tax on Economic Growth economists believe such a policy would reduce economic The effect of a carbon tax on economic growth depends efficiency, at least in the near- to medium-term. For greatly on the details of how the tax is designed, and espe- example, Lawrence Goulder and Marc Hafstead find that cially on what is done with the resulting revenues. Studies a lump-sum rebate is worse for economic growth than have found that while some uses of carbon tax revenues using revenues to reduce either personal or corporate would produce a net drag on economic growth, other uses income tax rates.112 And, while a 2014 study by Regional would provide a net stimulus to the economy. Of course, Economic Models, Inc. (REMI) found that a “fee-and- as with all economic modeling, much depends on the dividend” approach would yield small net positive impacts modelers’ assumptions (see Box 6 for further discussion on economic growth, this study was not peer-reviewed and on the limits of economic modeling). Here, we review the some experts have taken issue with its assumptions and economic literature to see how the choices made by poli- findings.113 cymakers regarding the structure of the tax and the use of FEDERAL DEFICIT REDUCTION. revenues will affect economic growth. Large deficits are thought to act as a drag on the economy, because they crowd out pri- CARBON TAX POLICY PROPOSALS AND THEIR vate sector investment, and interest payments on the debt EFFECTS ON ECONOMIC GROWTH reduce the amount of money that the federal government can spend on more constructive purposes. And if inter- Economists have undertaken considerable modeling est payments rise (or are expected to rise) in the future, and research on the economic impacts of various policy Congress may be forced to raise taxes to help defray those proposals and uses of revenues; those most commonly costs, further limiting output. Economists have mod- suggested are discussed in Section 5. Here, we’ll review eled the potential economic effects of carbon taxes with some of the economic literature to see how these revenue revenues used for federal deficit reduction by assuming, uses will impact growth. for example, that tax increases to reduce the debt are REDUCING DISTORTIONARY TAXES. Using carbon tax revenue inevitable, and carbon taxes can reduce the need for some to “pay for” reductions in taxes on capital or labor can of these future tax increases. partially or fully offset the adverse effects of a carbon tax Carbone et al. (2013) find that a CO tax of $30 per ton, on economic growth, though there is disagreement among 2 with all revenue used as a “down payment” to bring economists as to which of these uses of carbon tax revenue the debt down to a sustainable level, would lead to very would lead to greater economic growth. Economists refer minor GDP reductions in the near term, and either minor to taxes on capital and labor as distortionary, because increases or decreases following 2030, depending on the they reduce the incentives to work and invest—generally, choice of debt reduction measures for which carbon taxes things that policymakers want to encourage in a healthy

34 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

are substituted.114 Similarly, McKibbin et al. (2012) find Box 6 | Limits of Economic Modeling that, to achieve a given level of deficit reduction, a carbon tax reduces GDP slightly less than an equivalent tax on labor and slightly more than an equivalent tax on capital. They conclude that a carbon tax “offers a way to help Economists build models that aim to simulate the conditions, reduce the deficit and improve the environment, and do so operation, and behavior of real world economies. These models 115 can be powerful tools to help economists understand and with minimal disturbance to overall economic activity.” predict the behavior of economic actors, but they are necessarily simplifications, and have different strengths and weaknesses. The potential advantages of reducing deficits are not pres- They have some explanatory power, but they cannot predict the ent only at the federal level. Eisenberg et al. (2014) see future. similar benefits for states that use a carbon tax to comply with federal carbon-pollution standards for power plants, Some of the discrepancy between predicted and actual costs of new rules is the result of changes made by affected entities to using that revenue to reduce state deficits and lower other mitigate costs once those rules are implemented. Like models 116 tax rates. from other disciplines designed to mimic real-world conditions, economic models are premised upon the theories, assumptions, 6.1.2. Effects of a Carbon Price on Employment and policy design choices of their creators, and those theories From an environmental standpoint, the primary goal of and assumptions may be flawed, incomplete, or unproven. Moreover, given the wide range of views in the economics a carbon tax is to reduce greenhouse gas emissions; a profession, there is likely to be another economist—and another well-designed tax will entail some restructuring of the model—with contrasting assumptions and vastly different economy as a result of reductions in the use of carbon- results. In this paper, we strive to present an unbiased view of intensive fuels and the consumption of carbon-intensive different modeling results, noting when those results are largely goods. There is no consensus among economists on the in agreement with each other and when they are not. effects of carbon pricing on overall employment levels in According to previous analysis by WRI and others, economic the near term, although it is well recognized that there will models also have a history of overstating the costs of environ- be “winners” and “losers” from different economic sectors, mental measures while undervaluing the benefits of action to and most economists agree that any economic impacts will address climate change.a We encourage readers to keep in mind be limited in the long term. The non-partisan Congres- that all the economic modeling results discussed in this section are estimates, and that changes to policy design that depart from sional Budget Office (CBO) found that “[w]orkers and what researchers have modeled, can have an impact on model- investors in fossil-fuel industries (such as coal mining and ing results. oil extraction) and in energy-intensive industries (such as chemicals, metals, and transportation) would tend to Economic models are also limited in their ability to reflect the benefits of preserving “natural capital,” which includes experience comparatively large losses in income under resources such as forests, clean air, and clean water. When a carbon tax because demand for their products would economic impacts are measured in terms of gross domestic decline.”117 However, the same analysis found that job product (that is, the total value of the goods and services in an losses would be offset over time by job gains in low-emit- economy), any degradation of natural capital will generally be ting energy industries (such as wind, solar, and nuclear) unaccounted for. Economic models also typically fail to reflect as well as the service sector and other industries that are the benefits of preserving other valuable resources (for example, minerals and fuels) or a stable climate. Thus the business-as- comparatively less emissions-intensive. Further discus- usual or reference scenarios may be more optimistic than reality, sion on how a carbon tax affects employment in different once the impacts of climate change are reflected. regions and sectors can be found in Section 6.2, below. Notes: In the aggregate, because a carbon tax would affect prices a. On the tendency of industry and EPA models to overstate the costs of environmental regulations, see http://pdf.wri.org/factsheets/factsheet_for_ throughout the economy, there would likely be shifts in epa_regulations_cost_predictions_are_overstated.pdf. On the tendency employment levels within industries, though the impact for economic modeling to undervalue the benefits of acting on climate, on overall employment levels depends on the size of the see http://static.newclimateeconomy.report/wp-content/uploads/2014/08/ NCE_Chapter5_EconomicsOfChange.pdf. tax and what is done with revenue, and is likely to be small. In a 2010 review of the literature, CBO found that a “gradually increasing tax on greenhouse gas emissions or a cap-and-trade program … would probably have only a small effect on total employment during the next few decades.”118 In addition, CBO found that initially “job

WORKING PAPER | April 2015 | 35 losses from the industries that shrink would lower overall tile, but only a 0.7 percent burden on the top quintile.125 At employment in the economy and raise the unemployment the extreme ends of the income distribution, the regres- rate,” but over time most of these displaced workers would sivity of a carbon tax is even more pronounced—Mathur find jobs in less emissions-intensive industries and the and Morris (2012) found that an illustrative carbon tax of economy would eventually return to full employment.119 $15 per ton would account for 3.5 percent of income for As discussed in Section 5, the OECD found that using households in the bottom decile, but only 0.6 percent in carbon-tax revenue to reduce labor taxes would lead to faster the top decile.126 growth in total employment than would be the case in the absence of such a tax swap.120 In the long run, carbon taxes Several studies—including Mathur and Morris (2012), are expected to improve economic growth significantly by Dower and Zimmerman (1992), and Hassett et al. (2007) mitigating adverse effects of climate change, and overall —find that a carbon tax is comparatively less regres- employment tends to grow with the economy as a whole. sive when looking at impacts on consumption instead of income. For example, when measuring the effect of a Rausch and Reilly (2012) argue for using tax revenue carbon tax on consumption, Mathur and Morris estimate to offset either capital or labor taxes, to avoid spending that the same $15 per ton tax would reduce consumption cuts on social welfare programs, to pay down the deficit, in the bottom decile by 2.1 percent, and in the top decile or a combination thereof. They find that any of these by 1.3 percent. suggested uses would lead to improvements throughout the economy, including greater private spending and Due to this greater proportional burden on the poor than employment.121 the rich, a carbon tax is considered a regressive tax, but this regressivity can be addressed through a variety of There is some agreement in the economic literature that ways of returning revenues to lower income households. a well-designed carbon tax will not have a significant, Williams et al. (2014) find that, while using carbon-price adverse effect on employment, if revenues are directed in revenue to cut capital taxes improves economic efficiency, ways that can partially or fully offset any job losses. Fossil it exacerbates the regressivity of a carbon tax.127 The fuel extraction, heavy manufacturing, and other emis- authors found that using the revenue to provide dividends sions-intensive industries would be affected the most, and to households, however, would mean that the lower three the transition could be difficult for many communities.122 quintiles of the income distribution would see a net benefit Job training programs and a steady and predictable rate of from the policy. Using revenues to reduce taxes on labor increase in the carbon tax rate could help mitigate any job falls in between these two options, doing more to help losses, but those will likely take some time for their impact lower income households than cutting capital taxes, but to be felt. Further discussion on how to mitigate negative doing less than providing lump-sum dividends. impacts on heavy industry can be found in Section 6.2.3. Eisenberg et al. (2014) suggest that, to offset regressivity, 6.2. Distributional Impacts tax revenues could go toward safety net programs that benefit the poor.128 While this study analyzed state-level 6.2.1. Effects of a Carbon Tax on Income carbon taxes as a means for complying with carbon pollu- A carbon tax increases the price of carbon-intensive fuels tion standards for power plants, the same approach could and, in the absence of any offsetting use of revenue, lower be used at the federal level. Existing federal programs income households would bear a proportionally greater that assist lower income families and individuals, and burden than higher income households because they tend could be vehicles for distributing tax revenues to various to spend a higher proportion of their income on energy.123 constituencies, include Social Security, the Earned Income For example, CBO has found that a carbon tax of $28 per Tax Credit, Temporary Assistance for Needy Families, metric ton of CO2 emissions would increase after-tax costs the Low Income Home Energy Assistance Program, and for the average household in the lowest quintile of the the Supplemental Nutritional Assistance Program (also income distribution by 2.5 percent; for households in the called food stamps), among others. Other approaches top quintile, the carbon tax would increase after-tax costs include targeted tax cuts, such as the “environmental by only one percent.124 Marron and Toder (2013) found earned income tax credit” as proposed by Metcalf (2008), similar regressivity from a $20 per ton carbon tax—a 1.8 or including Social Security recipients in any payroll tax percent burden on the pre-tax income of the lowest quin- reduction (see Table 4) (Metcalf 2009).129 Metcalf pro-

36 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Table 4 |  Income Effects of a Carbon Tax, and Various Proposals to Reduce Regressivity

Change in Disposable Income ($) Change as a Percentage of Income

Income Group Carbon tax Tax credit Net Carbon tax Tax credit Net (decile)

1 (lowest) -276 208 -68 -3.4 2.7 -0.7 2 -404 284 -120 -3.1 2.1 -1 3 -485 428 -57 -2.4 2.2 -0.2 4 -551 557 6 -2 2.1 0.1 5 -642 668 26 -1.8 1.9 0.1 6 -691 805 115 -1.5 1.8 0.3 7 -781 915 135 -1.4 1.6 0.2 8 -883 982 99 -1.2 1.4 0.2 9 -965 1035 70 -1.1 1.1 0 10 (highest) -1224 1093 -130 -0.8 0.8 0

Earned Income Earned Income and Social Security Lump Sum

Income Group Net ($) Net (%) Net ($) Net (%) Net ($) Net (%) (decile)

1 (lowest) -68 -0.7 112 1.4 166 2.1 2 -120 -1 125 1 128 1 3 -57 -0.2 114 0.6 120 0.6 4 6 0.1 70 0.3 103 0.4 5 26 0.1 54 0.1 108 0.3 6 115 0.3 66 0.1 26 0.1 7 135 0.2 35 0.1 -32 -0.1 8 99 0.2 -61 -0.1 -52 -0.1 9 70 0 -95 -0.1 -171 -0.2 10 (highest) -130 0 -332 -0.2 -355 -0.2

Source: Metcalf, G. 2009. “Designing a Carbon Tax to Reduce U.S. Greenhouse Gas Emissions.” Review of Environmental Economics and Policy, Vol. 3, Iss. 1, Winter. Available at: http://reep. oxfordjournals.org/content/3/1/63.full.pdf+html

Note: Illustrative example using a carbon tax of $15 per metric ton (in 2005 dollars). Positive numbers represent an increase in income, and negative numbers represent a decrease in income. “Tax credit” refers to a proposal to use carbon tax revenues to reduce payroll taxes, up to the first $560 in taxes owed. “Earned income and Social Security” is a proposal whereby Social Security recipients also receive a $560 rebate. And “Lump sum” is the effects of a proposal to return all revenues to households in the form of per capita lump-sum rebates of $274.

WORKING PAPER | April 2015 | 37 poses reducing payroll taxes for individuals up to a certain The Congressional Budget Office states that “[p]eople in level of income, while ensuring that workers with low regions of the country that rely on emission- intensive income tax liability receive enough support to ensure they industries for their livelihood or that use the most emis- are not adversely affected. sion-intensive fuels to produce power” are likely to bear a larger burden from the imposition of a carbon tax than Estimates of how much revenue is needed to offset much others, and “[p]arts of the country that rely on fossil fuels of this regressivity are more or less consistent across or energy-intensive production for income would experi- studies. Morris and Mathur (2014) find that ensuring the ence larger losses than other regions.”135 Policymakers bottom 20 percent of households (those with incomes less concerned with such effects have tools at their disposal to than 150 percent of the poverty line) are not made worse offset any increases in energy prices. For example, ACES off by a carbon tax would require about 15 percent of the devoted 23 percent of revenue in the early years to local 130 revenue from the tax. The analysis in Rosenbaum et al. electricity and natural gas distribution companies, to (2009) of the Waxman-Markey cap-and-trade bill from combat higher prices for those commodities.136 2009 found that the bill’s provision that 15 percent of auc- tion revenue be returned to low-income households would Yet it is important not to focus just on electricity use, ensure that households in the bottom income quintile transportation costs, or any other single aspect of con- were made slightly better off, on average. A cap-and-trade sumption, but rather to look at regional energy use and program that auctions off all allowances functions in many spending patterns more holistically. Morris and Mathur ways like a carbon tax, so the findings are relevant to a (2014) find that “regional analyses show that the burdens carbon tax as well. For reference, CBO’s analysis of the of a carbon tax as a share of income would not vary nearly Waxman-Markey bill found that, in 2020, the bill’s provi- as much as many fear,” because different regions have sions for returning revenue to consumers meant that the different consumption patterns for carbon-intensive goods average household in the bottom income quintile would and fuels, but relatively similar consumption patterns for see a net benefit of $125 per year. The other four quintiles non-energy goods and services.137 That said, they find that would see a net annual cost, on average, as follows: second Wisconsin, Illinois, Ohio, Indiana, and Michigan could quintile $150, third quintile $310, fourth quintile $375, see a slightly higher burden from a carbon tax due to and top quintile $165.131 their high gasoline consumption and greater total energy consumption as a share of income. 6.2.2. Regional Implications of a Carbon Tax Morris and Mathur are not alone in their conclusions, Gasoline, coal-fired electricity, and oil for home heating though the details do vary between studies. Metcalf also will all get more expensive under a carbon tax. Differing finds that a gradually increasing tax of $15 per ton CO consumption patterns and fuel mixes in the electric grid 2 equivalent “does not appear to disproportionately burden between states and regions mean that a carbon tax will one region of the country” after revenue is returned to affect consumers differently depending on where they households (Metcalf 2009). In analyzing the regional dis- live. For example, the average driver in Wyoming drives tribution effects of a carbon tax, Metcalf finds that, when nearly 22,000 miles per year—more than twice as far as revenues are returned via a payroll tax credit, there is a drivers in Alaska and the District of Columbia.132 In 2012, mere 0.6 percent difference in earned income between the 92 percent of the electricity generated in Kentucky came hardest hit region (Alabama, Kentucky, Mississippi, Ten- from coal, while in Idaho that figure was less than one nessee) and the regions least affected by the tax (the upper percent.133 And carbon-heavy heating oil is a significant Midwest and the Mountain West). And when revenues source of space heating in the Northeast, while much of are returned to households via a combination of payroll the rest of the country relies much more heavily on less tax reductions and Social Security rebates, this income carbon-intensive fuels like natural gas, propane, or grid discrepancy drops to 0.4 percent, with all regions better electricity to heat homes in wintertime (however, in states off (see Table 5). that are most heavily dependent on coal for electricity production, heating oil can be a less emissions-intensive Hassett et al. found less in the way of regional effects in a 134 method of home heating than grid electricity). Neverthe- 2009 study analyzing the impacts of a tax of $15 per ton of less, as discussed below, some policy options for returning carbon dioxide emissions from fossil fuels when measured revenues to households can make all regions better off. on a lifetime basis. The authors found that regional varia- tion in the burden from the carbon tax was modest even

38 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

Table 5 |  Regional Distribution Effects of a Carbon Tax, With Two Proposals for Revenue Use

Earned Income and Social Security Lump Sum

Region Net ($) Net (%) Net ($) Net (%)

New England -36 0.2 -65 -0.1

Middle Atlantic -13 0.2 -18 -0.2

East North Central -14 0.1 -37 -0.1

West North Central 52 0.5 -26 -0.2

South Atlantic 17 0.3 2 0.3

East South Central -6 0.3 -75 -0.2

West South Central -42 0.2 9 0.4

Mountain 46 0.5 34 0.4

Pacific -4 0.2 59 0.6

10 (highest) -332 -0.2 -355 -0.2

Source: Metcalf (2009).

Notes: Illustrative example using a carbon tax of $15 per metric ton (in 2005 dollars). Positive numbers represent an increase in income, and negative numbers represent a decrease in income. “Earned income and Social Security” is a proposal whereby Social Security recipients also receive a $560 rebate. And “Lump sum” is the effects of a proposal to return all revenues to households in the form of per capita lump sum rebates of $274. Regions are defined as follows: New England (Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont); Middle Atlantic (New Jersey, New York, Pennsylvania); East North Central (Illinois, Indiana, Michigan, Ohio, Wisconsin); West North Central (Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, South Dakota); South Atlantic (Florida, Georgia, Maryland, North Carolina, South Carolina, Virginia, West Virginia); East South Central (Alabama, Kentucky, Mississippi, Tennessee); West South Central (Arkansas, Louisiana, Oklahoma, Texas); Mountain (Arizona, Colorado, Idaho, Montana, Nevada, New Mexico, Utah, Wyoming); and Pacific (Alaska, California, Hawaii, Oregon, Washington).

though their analysis did not look at uses of revenue, and den of the carbon tax, but do little to correct for regional that “variation across regions is sufficiently small that one disparities. A lump-sum rebate would be more beneficial could argue that a carbon tax is distributionally neutral for evening out the incidence of the carbon tax across across regions.”138 regions but would lower overall welfare compared to a capital tax reduction. Reducing taxes on labor, however, Williams et al. (2014) found that, while a carbon tax would nearly eliminated regional disparities in the incidence of have a regionally diverse impact on electricity prices due the carbon tax, while providing much of the same eco- to differing fuel mixes, those regional variations could be nomic benefit as reducing taxes on capital. minimized through revenue recycling.139 Using carbon-tax revenues to reduce taxes on capital would reduce the bur-

WORKING PAPER | April 2015 | 39 6.2.3. Impact of a Carbon Price on Industrial under a carbon tax is more likely to be compliant with Competitiveness World Trade Organization (WTO) rules than similar mea- sures under a cap-and-trade program.142 Some emissions-intensive industries could see a decline in demand for their products under a carbon tax. Some Border tax adjustments are not without risk and some of those industries, such as electricity generation, don’t measure of controversy. First, compliance with WTO rules face competition from U.S. trade partners, simply because is not a given, though the WTO has acknowledged that it is the vast majority of what is produced is not imported possible to design a border tax for environmental reasons or exported.140 Other emissions-intensive industries, without running afoul of its rules.143 The border adjust- however, such as steel, chemicals, and other large energy ment must be designed in such a way that it does not favor users, do face such competition, and higher prices on domestically produced goods, or imports from certain inputs could raise concerns that the United States will be countries.144 If a provision were written in a way that takes a less attractive location for manufacturing and will lose into account the carbon-pricing policies of our trading international competitiveness, at least in the near term. partners, many (though not all) experts believe a U.S. However, these concerns may be unfounded, because carbon tax could pass muster with the WTO, though it many of the United States’ largest trading partners already could be challenged by other countries.145 Second, a border have carbon-pricing policies in place (see Appendix A for adjustment has the potential to spark trade disputes if more information on those countries’ policies). some countries believe that they are being unfairly singled out and retaliate with import tariffs of their own.146 Lastly, A 2009 interagency report assessing the impact of a border adjustments can be burdensome to implement, national cap-and-trade program on international com- because the carbon content of a vast array of imported petitiveness found that, on average, energy expenditures goods will be so difficult to determine.147 account for less than two percent of the value of U.S. manufacturing output, and that the majority of industries would not be noticeably adversely affected by a carbon price.141 Meanwhile, only 44 of the 500 largest manufac- 7. CONCLUSION turing industries qualified as trade-exposed, accounting for 12 percent of total manufacturing output and just six In this Handbook, we have laid out the fundamental percent of manufacturing employment, although they choices available to policymakers considering policies that were responsible for nearly half of all greenhouse gas put an explicit price on carbon emissions. Most of these emissions from manufacturing. decisions will be the results of political compromises, and there are a number of precedents in the recent past for Even a small increase in energy costs could make a big cooperation on this issue. While we can’t predict what difference in industries with tight profit margins, however, the future might hold for carbon pricing and views differ so it is important for policymakers to take steps to address sharply on some issues, a number of factors are in play the reduced competitiveness of some industries. Under a that could increase the appeal of such a policy to different cap-and-trade program, allowances can be freely allocated parts of the political spectrum in the United States in the to vulnerable industries to mitigate their trade exposure. coming years. Under a carbon tax, however, the most direct way to cor- rect the disadvantage to these industries may be through Bipartisan support for federal tax reform a border adjustment. In this way, imports from countries The past five years have seen increasing calls for an without comparable carbon pricing policies would be sub- overhaul of the federal tax code. Observers on both sides ject to a tariff according to the carbon content of the good, of the aisle, along with businesses and individual taxpay- and exports to such countries would have at least some ers, find it to be overly onerous and complicated, yet full of of their tax burden reduced. Implicit in such a measure is loopholes that allow individuals or companies to pay less an inducement to our trading partners to enact their own than their fair share of taxes. The top marginal corporate carbon-pricing policies. Harmonized policies would have tax rate is the highest in the developed world, yet a wide the advantage of generating domestic tax revenues rather array of deductions means that the effective corporate than tariff payments to other countries, and the potential tax rate is far lower, and closer to the average effective for a more effective multi-country effort to reduce emis- tax rate of other developed countries.148 The tax code is sions. Metcalf (2010) asserts that a border adjustment also full of conflicting incentives; for example, fossil-fuel

40 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

companies receive subsidies and targeted tax breaks, As discussed above, nine northeastern states operate even as renewable-energy companies receive tax credits a regional electricity sector cap-and-trade program, and subsidies for production and investment. All of these and California in 2012 initiated its own economy-wide complications and inconsistencies in the tax code have cap-and-trade program. As of this writing, stakeholders led many in Congress to call for significant tax reform. In in Massachusetts, Oregon, Vermont, and Washington, recent years, Republican and Democratic members of the among others, are advocating for a carbon tax to raise Senate Finance Committee have discussed simplifying the revenue for transportation infrastructure or other tax code by replacing most or all energy subsidies and tax purposes. And in response to the flexibility afforded them credits with a carbon tax or cap-and-dividend program.149 under the Clean Power Plan, many states are actively considering whether carbon pricing offers the least-cost Stated goals for deeper reductions in way of complying with GHG emissions standards for GHG emissions power plants. Successful implementation of these policies at the state level could lessen resistance at the federal level Under President Obama, the United States now has a plan for a similar carbon-pricing policy. in place to meet its near- and medium-term emissions reduction targets, and to continue driving reductions in Increased awareness of emissions from the largest emitting sectors in the years beyond. However, analysis by WRI has shown that admin- climate-related impacts istrative actions alone are likely insufficient to meet our From sea-level rise in Florida and Virginia, to increases long-term emissions target of roughly 83 percent below in the frequency and severity of some types of extreme 2005 levels by 2050.150 In short, the United States will weather events, to protracted droughts in Texas and Cali- need a comprehensive, economy-wide climate policy, such fornia, the United States is already seeing previews of what as a carbon tax or cap-and-trade program, if the country a warming planet holds in store. As climate impacts hit is to achieve the level of reductions that the IPCC says will home, and their effects begin taking a toll on the economy, be necessary from developed nations to avoid the worst we might see public opinion become increasingly vocal on impacts of climate change. the need to act. A climate policy that puts a price on GHG emissions throughout the economy offers policymakers a Desire for alternative climate policies proven, market-based solution to reduce the U.S. contri- A price on carbon is both a fiscal and an environmental bution to climate change and to raise revenues that can be policy. In addition to using revenues to “pay for” reduc- invested in technologies that enable communities to better tions in other taxes, as discussed above, some proponents adapt to the impacts of climate change. advocate an economy-wide carbon price as an approach While none of these factors alone will likely be enough that is preferable to imposing sectoral emission standards, to move Congress to put a price on carbon in the com- while others view such standards as important tools in ing years, their confluence suggests a gradual mounting their own right or as potentially complementary climate of pressure that could turn the tide. The world and the policies. American people are increasingly serious about the need 151 Bipartisan support for deficit reduction to act to avoid the worst impacts of climate change. A comprehensive carbon-pricing policy provides the oppor- While concerns about the national debt have subsided tunity to satisfy a variety of political goals beyond emis- to some extent in the past few years, reducing long-term sions reductions. We hope that this working paper—and debt remains an issue with significant support from the future briefing papers that will dive more deeply into general public and lawmakers on both sides of the aisle. A many of the issues raised here—can play a helpful role in national carbon tax has the potential to raise hundreds of the coming national conversation on these issues. billions of dollars per year that could be used to improve the United States’ long-term fiscal situation. Experience at the state level In the absence of a national, economy-wide policy to reduce GHG emissions, some states have moved forward with their own carbon-pricing mechanisms.

WORKING PAPER | April 2015 | 41 APPENDIX – GLOBAL CARBON PRICING SYSTEMS

Table A.1 |  Carbon taxes around the world

YEAR PORTION OF GHGS COUNTRY PRICE PER TON CO E REVENUE USAGE152 IMPLEMENTED 2 COVERED (%) Finland 1990 ▪▪ €35 ($48) for 15 ▪▪ Reduce income taxes heating fuels Increase government revenue €60 ($83) for ▪▪ ▪▪ liquid traffic fuels

Norway 1991 Nkr25 to 419 ($4-69) 50 Increase government revenue in 2014; depending on ▪▪ fuel type and usage

Sweden 1991 Skr1076 ($168) 25 ▪▪ Increase government revenue ▪▪ Offset labor taxes

Denmark 1992 Dkr167 ($31 in 2014) 45 ▪▪ 40 percent used as environmental subsidy ▪▪ 60 percent returned to industry

British 2008 C$30 ($28) in 70 ▪▪ Designed to be revenue neutral through income Columbia 2013/14 tax reductions and tax credits Revenue negative in practice - tax cuts and credits ▪▪ have exceeded carbon tax revenue Switzerland 2008 SFr60 ($68) from 30 ▪▪ Dividend redistributed proportionally to industry 2014 and consumers ▪▪ Fund climate-friendly building renovations

Iceland 2010 Íkr1120 ($10) 50 ▪▪ Increase government revenue

Ireland 2010 €20 ($28) from May 40 ▪▪ Increase government revenue (extended to solid 2014 Reduce the deficit fuels in 2013) ▪▪

Japan 2012 ¥192 ($2) from April 70 ▪▪ Invest in clean energy and energy efficiency 2014, increasing to ¥289 ($3) in April 2016

42 | PER TO

Putting a Price on Carbon: A Handbook for U.S. Policymakers

Table A.1 |  Carbon taxes around the world (continued)

YEAR PORTION OF GHGS COUNTRY PRICE PER TON CO E REVENUE USAGE152 IMPLEMENTED 2 COVERED (%) United 2013 ▪▪ EU ETS price floor 25 ▪▪ Reduce other taxes Kingdom of £16 ($26.23) in 2013 Effective tax in ▪▪ April 2014 of £9.55 ($15.75) Mexico 2014 ▪▪ Mex$10-50 Unclear – initial bill ▪▪ Increase government revenue ($1-4), depending included natural on fuel gas and would have covered 40 percent France April 1, 2014 ▪▪ €7 ($10) Initial coverage: ▪▪ Fund energy transition plans increasing to €14.5 35 percent ($20) in 2015 and €22 ($30) in 2016

South Implementation ▪▪ R120 ($12) in 80 ▪▪ Likely to be a reduction in VAT or income taxes Africa planned in 2016 2016 Increasing by 10 ▪▪ percent per year through 2019, then subject to review During 2016-19, ▪▪ a basic tax-free threshold will be established, making the maximum effective tax rate R48 ($5)

Chilea Goes into effect in $5 per ton no data ▪▪ Educational developments on climate change 2018 ▪▪ No detail on price ▪▪ increases ▪▪ Education system

Australia Initiated July 2012; ▪▪ A$24.15 ($21.54) 60 ▪▪ Revenue neutral: Reduce income tax and provide repealed in 2014 from July 2013 dividend to energy producers and consumers ▪▪ Funded industry assistance programs

Source: State and Trends of Carbon Pricing 2014, World Bank, Washington D.C. 2014. Dollar values are based on exchange rates as of December 31, 2013. Notes: a. Information from Reuters (“Chile becomes the first South American country to tax carbon,” Reuters, September 27, 2014) and Point Carbon (“Chile passes carbon tax,” Point Carbon,October 30, 2014).

WORKING PAPER | April 2015 | 43 Table A.2 |  National and Sub-National Greenhouse Gas Cap-and-Trade Programs Around the World

2013 YEAR EMISSIONS JURISDICTION PRICE PER COVERED SECTORS IMPLEMENTED COVERED (%) TON CO2E

European Union 2005 45 $9 Industry, electricity, aviation

New Zealand 2008 50 $1 Industry, forestry, transport, waste

Switzerland 2008 10 Electricity, buildings

U.S. Sub-national Programs

Regional Greenhouse Gas Initiative 2009 20 $3 Electricity ▪▪ (RGGI) – NE United States

2013 85 $11 From 2013: Industry, electricity; added in California ▪▪ (linked with Quebec) 2015: transport, distributed use of fuels

2012; 60 $21.54 All large emission sources, including industry, Australia repealed 2014 (fixed large gas consumers, and landfills price)

Canada Sub-national Program

Quebec 2013 85 $10 From 2013: Industry, electricity; added in (linked with California) 2015: transport, distributed use of fuels

Chinese Sub-national Pilots

Tianjin 2013 60 $4 Industry, electricity, buildings Beijing 2013 50 $9 Industry, electricity, buildings Shanghai 2013 50 $5 Industry, transport, electricity Guangdong 2013 42 $10 Industry, electricity Shenzhen 2013 38 $11 Industry, electricity, buildings Chongqing 2014 38 Electricity Hubei 2014 35 Industry, electricity

Kazakhstan 2013 50 Industry, transport, electricity, agriculture

South Korea 2015 (planned) 60 Industry, electricity

Source: World Bank, State and Trends of Carbon Pricing 2014, unless otherwise noted.

Notes: This table does not include Alberta (Canada) or Tokyo, Saitama and Kyoto (Japan), which have initiated trading systems based on emissions intensity. California’s program went into effect in 2012, but the first year for which covered entities had emissions obligations was 2013. The portion of emissions covered in California and Quebec reflects the increase in scope at the start of 2015 to include transportation fuels and distributed use of natural gas and other fuels. Australia’s system, which has now been repealed, was initiated with a fixed price and was therefore, in its initial stages, a carbon tax.

44 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

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WORKING PAPER | April 2015 | 47 ENDNOTES 1. Horvitz, P.F. June 9, 1993. “Clinton Retreats on Energy Tax in Fight 12. Shultz, George P. March 13, 2015. “A Reagan Approach to Over Budget.” The New York Times. Also available at: http://www. Climate Change.” Washington Post. Also available at: http:// nytimes.com/1993/06/09/news/09iht-plan_1.html. www.washingtonpost.com/opinions/a-reagan-model-on-climate- change/2015/03/13/4f4182e2-c6a8-11e4-b2a1-bed1aaea2816_story. 2. Conniff, R. August 2009. “The Political History of Cap and Trade.” html Smithsonian Magazine. See: http://www.smithsonianmag.com/air/the- political-history-of-cap-and-trade-34711212/?page=2 13. Paulson, Henry M. June 21, 2014. “The Coming Climate Crash: Lessons for Climate Change in the 2008 Recession.” The New York 3. World Bank. May 28, 2014. State and Trends of Carbon Pricing 2014. Times. Also available at: http://www.washingtonpost.com/opinions/a- Washington, D.C.: World Bank. reagan-model-on-climate-change/2015/03/13/4f4182e2-c6a8-11e4- b2a1-bed1aaea2816_story.html 4. Ontario Office of the Premier, “Statement of Intent Between the Government of Ontario and the Gouvernement Du Québec Concerning 14. See http://republicen.org/ Cooperation on Market Based Mechanisms,” April 13, 2015. Available at: http://news.ontario.ca/opo/en/2015/04/statement-of-intent-between- 15. See, for example, Mankiw, N. Gregory. “Smart Taxes: An Open the-government-of-ontario-and-the-gouvernement-du-quebec- Invitation to Join the Pigou Club.” Eastern Economic Journal 35, 14-23 concerning-coop.html (2009). Available at: http://scholar.harvard.edu/files/mankiw/files/ smart_taxes.pdf 5. Interagency Working Group on Social Cost of Carbon, United States Government. Technical Support Document: Technical Update of the 16. See, for example, Wolf, Amy. February 20, 2012. “Economist Arthur Social Cost of Carbon for Regulatory Impact Analysis Under Executive Laffer Proposes Taxing Pollution Instead of Income.” Vanderbilt News. Order 12866. Revised November 2013. Available at: http://www. Also available at: http://news.vanderbilt.edu/2012/02/economist- whitehouse.gov/sites/default/files/omb/assets/inforeg/technical-update- arthur-laffer-proposes-taxing-pollution/ social-cost-of-carbon-for-regulator-impact-analysis.pdf 17. See, for example, Green, Kenneth P., Hayward, Steven F., and Kevin 6. The University of Chicago Booth School of Business. December A. Hassett. “Climate Change: Caps vs. Taxes.” American Enterprise 4, 2012. Carbon Taxes II. Chicago: IGM Economic Experts Panel. Institute for Public Policy Research Environmental Policy Outlook Available at: http://www.igmchicago.org/igm-economic-experts-panel/ No. 2, June 2007. Available at: https://www.aei.org/wp-content/ poll-results?SurveyID=SV_8oABK2TolkGluV7 uploads/2011/10/20070601_EPOg.pdf

7. See, for example: Bento, A. and M. Jacobsen. 2007. “Ricardian Rents, 18. See “Considering a U.S. Carbon Tax,” Resources for the Future, Environmental Policy, and the “Double Dividend” Hypothesis.” Journal accessed April 13, 2015, http://www.rff.org/centers/energy_and_ of Environmental Economics and Management 53(1): 17–31. climate_economics/Pages/Considering-a-US-Carbon-Tax.aspx

8. Carbone, J.C., R.D. Morganstern, R.C. Williams III, and D. Burtraw. 19. See, for example, Morris, Adele C. and Aparna Mathur. May 2014. “A August, 2013. “Deficit Reduction and Carbon Taxes: Budgetary, Carbon Tax in Broader U.S. Fiscal Reform: Design and Distributional Economic, and Distributional Impacts.” Washington, D.C.: Resources Issues.” Washington, DC: Center for Climate and Energy Solutions. for the Future. Available at: http://www.weathervane.rff.org/RFF/ Available at: http://www.brookings.edu/research/papers/2014/05/22- Documents/RFF-Rpt-Carbone.etal.CarbonTaxes.pdf carbon-tax-in-broader-us-fiscal-reform-morris

9. Mathur, A. and A. Morris. 2012. “Distributional Effects of a Carbon 20. See, for example, “Idea of the Day: We Should Have a Progressive Tax in Broader U.S. Fiscal Reform.” Washington, D.C.: The Brookings Carbon Tax,” Center for American Progress, December 6, 2012. Institution. Available at: http://www.brookings.edu/~/media/research/ Available at: https://www.americanprogress.org/issues/general/ files/papers/2012/12/14%20carbon%20tax%20fiscal%20reform%20 news/2012/12/06/47139/idea-of-the-day-we-should-have-a- morris/14%20carbon%20tax%20fiscal%20reform%20morris.pdf progressive-carbon-tax/

10. See, for example, Morris, A. and A. Mathur. “A Carbon Tax in 21. “Carbon Fee and Dividend Explained,” Citizens Climate Lobby, Broader U.S. Fiscal Reform: Design and Distributional Issues.” 2014. accessed April 13, 2015, https://citizensclimatelobby.org/carbon-fee- Washington, D.C.: The Brookings Institution. Available at: http://www. and-dividend/ brookings.edu/research/papers/2014/05/22-carbon-tax-in-broader-us- fiscal-reform-morris Additional studies are discussed in Section 5 of 22. Taylor, J. March 2015. “The Conservative Case for a Carbon Tax.” this paper. Washington, DC: Niskanen Center.

11. Environmental Protection Agency. December 2, 2009. “The Effects of 23. See, for example, Thompson, T.M. et al. 2014. “A systems approach H.R. 2454 on International Competitiveness and Emission Leakage to evaluating the air quality co-benefits of US carbon policies.”Nature in Energy-Intensive Trade-Exposed Industries.” Washington, DC: Climate Change 4, 917–923 (2014). Available at: http://www.nature. Environmental Protection Agency. Available at: http://www.epa. com/nclimate/journal/v4/n10/full/nclimate2342.html gov/climatechange/Downloads/EPAactivities/InteragencyReport_ Competitiveness-EmissionLeakage.pdf

48 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

24. For example, coal-fired power plants emit pollutants into the air and 36. China’s economic planning agency, the National Development and water that can be detrimental to human health and the environment. For Reform Commission (NDRC), has submitted regulations for a national- more information, see http://www.epa.gov/cleanenergy/energy-and- level emissions trading system to the State Council for approval. you/affect/coal.html Kathy Chen and Stian Reklev. August 31, 2014. “China’s National Carbon Market to Start in 2016—Official.”Reuters. Also available 25. For a more complete discussion comparing carbon taxes to cap-and- at: http://uk.reuters.com/article/2014/08/31/china-carbontrading- trade programs, see Goulder and Schein, “Carbon Taxes Versus Cap idUKL3N0R107420140831. and Trade: A Critical Review.” Climate Change Economics Vol. 4, No. 3, 2013. 37. Some provinces will be allowed to delay participation in the emissions trading system if they do not have the technical 26. Dower, R.C. and M.B. Zimmerman. August, 1992. “The Right Climate infrastructure to participate from the beginning. http://uk.reuters.com/ for Carbon Taxes: Creating Economic Incentives to Protect the article/2014/08/31/china-carbontrading-idUKL3N0R107420140831 Environment.” Washington, D.C.: World Resources Institute. Available at: http://www.wri.org/publication/right-climate-carbon-taxes 38. CDP. December, 2013. “Use of internal carbon price by companies as incentive and strategic planning tool: A review of findings from 27. The plan would have applied the tax to most forms of energy, including CDP 2013 disclosure.” New York, NY: CDP. See: http://big.assets. hydropower and nuclear power, but it would have exempted solar, wind huffingtonpost.com/22Nov2013-CDP-InternalCarbonPriceReprt.pdf and geothermal energy. For more information, see: Greenhouse, Steven. February 18, 1993. “Clinton’s Economic Plan: The Energy Plan; Fuels 39. WRI (World Resources Institute). CAIT 2.0, accessed April Tax: Spreading the Burden.” The New York Times. Also available at: 13, 2015. http://cait2.wri.org/wri/Country%20GHG%20

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N2O&indicator[]=Total F-Gas&year[]=2011&country[]=United%20State 28. Horvitz, P.F. June 9, 1993. “Clinton Retreats on Energy Tax in Fight s&country[]=World&sortDir=asc&chartType=pie Over Budget.” The New York Times. Also available at: http://www. nytimes.com/1993/06/09/news/09iht-plan_1.html 40. For a full discussion of global warming potential, see Myhre, G., D. Shindell, F.-M. Bréon, W. Collins, J. Fuglestvedt, J. Huang, D. Koch, J.- 29. For summaries and analyses of the various bills that were introduced F. Lamarque, D. Lee, B. Mendoza, T. Nakajima, A. Robock, G. Stephens, between 2003 and 2010, see http://www.wri.org/publication/emissions- T. Takemura and H. Zhang, 2013: Anthropogenic and Natural Radiative reductions-under-pollution-reduction-proposals-111th-us-congress Forcing. In: Climate Change 2013: The Physical Science Basis. Contribution of Working Group I to the Fifth Assessment Report of the 30. American Opportunity Carbon Fee Act, S. 2940, 113th Congress Intergovernmental Panel on Climate Change [Stocker, T.F., D. Qin, G.-K. (2014): Introduced by Senators Sheldon Whitehouse and Brian Schatz. Plattner, M. Tignor, S.K. Allen, J. Boschung, A. Nauels, Y. Xia, V. Bex Available at https://www.govtrack.us/congress/bills/113/s2940 and P.M. Midgley (eds.)]. Cambridge University Press, Cambridge, United Kingdom and New York, NY, USA. Available at: http://www. 31. Healthy Climate and Family Security Act of 2015, H.R. 1027, 114th climatechange2013.org/images/report/WG1AR5_Chapter08_FINAL.pdf Congress (2015). Introduced by Representative Chris Van Hollen. Available at https://www.govtrack.us/congress/bills/114/hr1027 41. “Power Plants,” U.S. Environmental Protection Agency Greenhouse Gas Reporting Program, accessed April 13, 2015, http://www.epa.gov/ 32. For more information on the RGGI program review, see “2012 Program ghgreporting/ghgdata/reported/powerplants.html. Review,” Regional Greenhouse Gas Initiative, accessed April 13, 2015, http://www.rggi.org/design/program-review. 42. U.S. Environmental Protection Agency, U.S. Greenhouse Gas Inventory. http://www.epa.gov/climatechange/ghgemissions/usinventoryreport. 33. “Design Recommendations,” Western Climate Initiative, accessed April html 13, 2015, http://www.westernclimateinitiative.org/the-wci-cap-and- trade-program/design-recommendations. 43. Houser, T. et al. May, 2008. “Leveling the Carbon Playing Field.” Washington, DC: Peterson Institute for International Economics and 34. Ontario Office of the Premier, “Statement of Intent Between the World Resources Institute. Available at: http://pdf.wri.org/leveling_the_ Government of Ontario and the Gouvernement Du Québec Concerning carbon_playing_field.pdf Cooperation on Market Based Mechanisms,” April 13, 2015. Available at: http://news.ontario.ca/opo/en/2015/04/statement-of-intent-between- 44. Interagency Working Group on Social Cost of Carbon, United States the-government-of-ontario-and-the-gouvernement-du-quebec- Government. 2013. “Technical Update of the Social Cost of Carbon for concerning-coop.html Regulatory Impact Analysis Under Executive Order 12866.” Technical Support Document. Revised November 2013. Available at: http://www. 35. For data point on emissions in jurisdictions with pricing programs, whitehouse.gov/sites/default/files/omb/assets/inforeg/technical-update- see “What Does it Mean to Put a Price on Carbon?” June 11, 2014. social-cost-of-carbon-for-regulator-impact-analysis.pdf The World Bank. Available at: http://www.worldbank.org/en/news/ feature/2014/06/11/what-does-it-mean-to-put-a-price-on-carbon. For 45. See, for example, Moore, F.C. and D.B. Diaz. 2015. “Temperature data on emissions covered by these programs, see World Bank, State impacts on economic growth warrant stringent mitigation policy.” and Trends of Carbon Pricing 2014. Nature Climate Change 5: 127–131. Available at: http://www.nature. com/nclimate/journal/v5/n2/full/nclimate2481.html

WORKING PAPER | April 2015 | 49 46. British Columbia Climate Action Plan. 2008. Available at: http://www. 58. The Global Commission on the Economy and Climate. September, gov.bc.ca/premier/attachments/climate_action_plan.pdf 2014. “Better Growth, Better Climate.” Washington, DC: Global Commission on the Economy and Climate. Available at: http:// 47. For information on RGGI, see: http://www.eia.gov/todayinenergy/detail. newclimateeconomy.report/ cfm?id=14851. For information on EU-ETS, see: http://ec.europa.eu/ clima/policies/ets/pre2013/index_en.htm and http://ec.europa.eu/ 59. See, for example, George P. Shultz and Gary S. Becker. April 7, 2013. clima/policies/ets/index_en.htm “Why We Support a Revenue-Neutral Carbon Tax.” The Wall Street Journal. Also available at: http://www.wsj.com/articles/SB10001424127 48. No GHG cap-and-trade programs have had this experience to date, 887323611604578396401965799658. but the RECLAIM market for NOx emissions in Southern California experienced extreme increases in prices in 2000 and 2001 during 60. See, for example, “Carbon Fee and Dividend Explained,” Citizens Climate the Californian electricity crisis. For a discussion of the lessons Lobby, accessed April 13, 2015, https://citizensclimatelobby.org/carbon- from RECLAIM’s experience, see ”Air Actions, California,” U.S. fee-and-dividend/ and Richard W. Caperton. December 6, 2012. “A Environmental Protection Agency, accessed April 13, 2015, http://www. Progressive Carbon Tax Will Fight Climate Change and Stimulate epa.gov/region09/air/reclaim/ the Economy.” Center for American Progress. Available at: https:// www.americanprogress.org/issues/green/report/2012/12/06/47052/a- 49. For an overview of the experience in the initial stages of the Clean progressive-carbon-tax-will-fight-climate-change-and-stimulate-the- Development Mechanism, the main offset mechanism set up economy/. under the UNFCCC, including its successes and its struggles, see Gillenwater, Michael and Stephen Seres, March 2011. “The Clean 61. See, for example, Andrew Moylan. October 2, 2013. “How to Tax Development Mechanism: A Review of the First International Offset Carbon.” The American Conservative. Available at: http://www. Program.” Washington, D.C.: Pew Center for Global Climate Change. theamericanconservative.com/articles/how-to-tax-carbon/. Available at: https://ghginstitute.org/wp-content/uploads/2011/03/ PEW8037CDMReport.pdf 62. “Carbon Fee and Dividend Explained,” Citizens Climate Lobby, accessed April 13, 2015, https://citizensclimatelobby.org/carbon-fee- 50. High quality offsets are real, permanent, additional, verifiable, and and-dividend/ enforceable. 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70. Congressional Budget Office. “Federal Debt and the Risk of a Fiscal 82. See Levin et al. (2012) for further discussion. Crisis.” Washington, D.C. July 27, 2010. Available at: http://www.cbo. gov/sites/default/files/07-27_debt_fiscalcrisis_brief.pdf 83. OECD. 2014. “Switzerland economic forecast summary November 2014.” Paris. Organisation for Economic Cooperation and Development. 71. See, for example, Richard W. Caperton. December 6, 2012. “A Available at: http://www.oecd.org/economy/switzerland-economic- Progressive Carbon Tax Will Fight Climate Change and Stimulate the forecast-summary.htm Economy.” Center for American Progress. Available at: https://www. americanprogress.org/issues/green/report/2012/12/06/47052/a- 84. For U.S. coal production data, see “Coal: Production,” U.S. Energy progressive-carbon-tax-will-fight-climate-change-and-stimulate-the- Information Administration, accessed April 13, 2015, http://www.eia. economy/ gov/coal/data.cfm#production

72. “Historical Tables,” White House Office of Management and Budget, 85. For household heating data, see “Household Heating Fuels Vary Across accessed April 13, 2015, https://www.whitehouse.gov/omb/budget/ the Country,” U.S. Energy Information Administration, October 28, Historicals. 2011, http://www.eia.gov/todayinenergy/detail.cfm?id=3690.

73. “Government Deficit/Surplus, Debt and Associated Data,” Eurostat, 86. See, for example, Morris, A. and A. Mathur. 2014. “A Carbon Tax updated February 27, 2015, http://appsso.eurostat.ec.europa.eu/nui/ in Broader U.S. Fiscal Reform: Design and Distributional Issues.” show.do?dataset=gov_10dd_edpt1&lang=en Washington, D.C.: The Brookings Institution. Available at: http://www. brookings.edu/research/papers/2014/05/22-carbon-tax-in-broader-us- 74. Frank Convery. 2013. “Budget 2013—Three Cheers for the Carbon fiscal-reform-morris. Additional studies are discussed in Section 5 Tax.” Publicpolicy.ie. Available at: http://www.publicpolicy.ie/wp- content/uploads/Budget-2013-Three-cheers-for-the-Carbon-tax1.pdf. 87. Edison Electric Institute. August 2014. “Different Regions of the Country Use Different Fuel Mixes to Generate Electricity.” Washington, 75. See, for example: http://www.careeronestop.org/, http://www.jobcorps. DC. Available at: http://www.eei.org/issuesandpolicy/generation/ gov/home.aspx, and http://www.valu.va.gov/Home/Index fueldiversity/Documents/map_fuel_diversity.pdf

76. Levin, K., B. Cashore, S. Bernstein, and G. Auld. 2012.“Overcoming 88. Metcalf, G. 2009. “Designing a Carbon Tax to Reduce U.S. Greenhouse the tragedy of super wicked problems: constraining our future selves to Gas Emissions.” Review of Environmental Economics and Policy, ameliorate global climate change.” Policy Sciences. Vol. 45, Iss. 2: 123- Vol. 3, Iss. 1, Winter. Available at: http://reep.oxfordjournals.org/ 152. June. Available at: http://www.reshape.se/files/8514/2071/1788/ content/3/1/63.full.pdf+html Overcoming_the_tragedy_of_super_wicked_problems.pdf 89. For more information on whether and how a U.S. carbon tax can be 77. See, for example: “Assistance for Coal Miners Who Have Been Laid designed in order to comply with World Trade Organization rules, Off, Work Force West Virginia, accessed April 13, 2015, http://www. see Jennifer Hillman. July 25, 2013. “Changing Climate for Carbon wvcommerce.org/business/workforcewv/job_seekers/minelayoff.aspx Taxes: Who’s Afraid of the WTO?” Washington, DC: The German and “Hiring Our Miners Everyday,” Kentucky Career Center, accessed Marshall Fund of the United States. Available at: http://www.gmfus. April 13, 2015, http://www.jobsight.org/jobseeker/coalminers. org/publications/changing-climate-carbon-taxes-who%E2%80%99s- afraid-wto; Pauwelyn , Joost, Carbon Leakage Measures and Border 78. Osikominu, A. 2013. “Quick Job Entry or Long-Term Human Capital Tax Adjustments Under WTO Law (March 21, 2012). Available at: http:// Development? The Dynamic Effects of Alternative Training Schemes.” ssrn.com/abstract=2026879; and Steve Charnovitz. September 29, Review of Economic Studies, (2013) 80 (1): 313-342. Available at: 2014. “Border Tax Equalization (Draft Paper Prepared for the Conference http://restud.oxfordjournals.org/content/80/1/313 on Challenges Facing the World Trade System).” Available at: http:// indianeconomy.columbia.edu/sites/default/files/paper2-bordertax.pdf . 79. Canadian Apprenticeship Forum. June, 2009. “It Pays to Hire an Apprentice: Calculating the Return on Training Investment for 90. Sumner, J., L. Bird, and H. Smith. December, 2009. “Carbon Taxes: A Skilled Trades Employers in Canada.” Ottawa, Canada: Canadian Review of Experience and Policy Design Considerations.” Golden, CO: Apprenticeship Forum. Available at: http://www.novascotia.ca/lae/ National Renewable Energy Laboratory. Available at: http://www.nrel. Apprenticeshipboard/documents/CAF-FCA_ROTI_it_pays_to_hire_an_ gov/docs/fy10osti/47312.pdf apprentice_ExecutiveReport_En_000.pdf. 91. “Global Market Share of the World’s Leading Wind Turbine 80. Danielle Scalise. October 6, 2014. “Chile to Implement Carbon Tax Manufacturers in 2013, Based on Sales in Gigawatts,” Statista, Complimenting the Latin American Trend of Environmental Reform.” accessed April 13, 2015, http://www.statista.com/statistics/272813/ Panoramas. Also available at: http://www.panoramas.pitt.edu/content/ market-share-of-the-leading-wind-turbine-manufacturers-worldwide/. chile-implement-carbon-tax-complimenting-latin-american-trend- environmental-reform. 92. “Wind Turbines Reached Record Level in 2014,” Energinet.dk, January 20, 2015, http://energinet.dk/EN/El/Nyheder/Sider/Vindmoeller-slog- 81. Boyce, J., and M. Riddle. November, 2007. “Cap and Dividend: How rekord-i-2014.aspx. to Curb Global Warming While Protecting the Incomes of American Families.” Amherst, MA: Political Economy Research Institute. Working 93. Caperton, R. 2012. “A Progressive Carbon Tax Will Fight Climate Paper Series. Available at: http://scholarworks.umass.edu/cgi/ Change and Stimulate the Economy.” Center for American Progress, viewcontent.cgi?article=1121&context=peri_workingpapers. December 6, 2012. Available at: http://cdn.americanprogress.org/wp- content/uploads/2012/12/CAPERTONCarbonTax.pdf.

WORKING PAPER | April 2015 | 51 94. For more information on the Green Climate Fund, see: http://unfccc.int/ 106. Amdur, D., B. Rabe and C. Borlick. “Public Views on a Carbon Tax cooperation_and_support/financial_mechanism/green_climate_fund/ Depend on the Proposed Use of Revenue.” CLOSUP (Center for Local, items/5869.php and http://news.gcfund.org/ State and Urban Policy), University of Michigan. July 2014. http:// closup.umich.edu/files/ieep-nsee-2014-spring-carbon-tax.pdf 95. The World Bank. 2010. “Economics of Adaptation to Climate Change, Synthesis Report.” January. Washington, D.C.: The World 107. Center on Budget and Policy Priorities. May 12, 2008. “Climate Bank. Available at: http://documents.worldbank.org/curated/ Change Policies Can Treat Low-Income Families Fairly and Be Fiscally en/2010/01/16436675/economics-adaptation-climate-change- Responsible.” Available at: http://www.cbpp.org/files/climate-brochure. synthesis-report pdf

96. Sussman, F., N. Krishnan, K. Maher, R. Miller, C. Mack, P. Stewart, K. 108. Pew Center on Global Climate Change. August, 2009. “Distribution Shouse, and W. Perkins. “Climate Change Adaptation Cost in the U.S.: of Allowances Under the American Clean Energy and Security Act What Do We Know?” Climate Policy, Vol. 14, No. 2: 242-282. Available (Waxman-Markey).” Pew Center, Washington, D.C. Available at: http:// at: http://www.tandfonline.com/action/showCitFormats?doi=10.1080% www.c2es.org/docUploads/policy-memo-allowance-distribution-under- 2F14693062.2013.777604& waxman-markey.pdf

97. http://www.bmub.bund.de/en/topics/climate-energy/climate-initiative/ 109. Horowitz, C., M.R. Enion, S.B. Hecht and A. Carlson. “Spending general-information/ California’s Cap-and-Trade Auction Revenue: Understanding the Sinclair Paint Risk Spectrum.” Emmitt Center on Climate Change 98. http://www.rggi.org/docs/Documents/2012-Investment-Report.pdf and the Environment, UCLA School of Law. March 2012. http://law. ucla.edu/~/media/Files/UCLA/Law/Pages/Publications/CEN_EMM_ 99. OECD (Organisation for Economic Cooperation and Development). PUB%20Spending_CA_Cap_Trade_Revenue.ashx 2010. “Taxation, Innovation and the Environment.” Executive Summary. Paris: OECD. Available at: http://www.oecd.org/env/tools- 110. For more information, see: http://www.arb.ca.gov/cc/capandtrade/ evaluation/46177075.pdf. auctionproceeds/budgetappropriations.htm

100. The IPCC estimates that, in order to keep warming to two degrees 111. Parry, I., and R. Williams III. 2011. “Moving U.S. Climate Policy Celsius, global emissions must be approximately 80-95 percent below Forward: Are Carbon Taxes the Only Good Alternative?” Washington, 2000 levels by 2050, though reductions would likely need to be even D.C.: Resources for the Future. Available at: http://www.rff.org/RFF/

greater in developed countries. Global emissions of CO2 would need to Documents/RFF-DP-11-02.pdf be net zero by 2070, and all greenhouse gases would need to be phased out by 2100. For more information, see: https://www.ipcc.ch/pdf/ 112. Goulder, L.H. and M.A. C. Hafstead. October 8, 2013. “Tax Reform and assessment-report/ar5/wg3/ipcc_wg3_ar5_chapter6.pdf Environmental Policy: Options for Recycling Revenue from a Tax on Carbon Dioxide”. Washington, D.C.: Resources for the Future. Available 101. See, for example: Jesse Jenkins. July 28, 2014. “When Politics at: http://ssrn.com/abstract=233821 Constrains Carbon Pricing, Part 3: Why Carbon Revenues Are Just As Important As ‘Putting a Price on Carbon.’” The Energy Collective. 113. Regional Economic Models, Inc. and Synapse Energy Economics, Available at: http://theenergycollective.com/jessejenkins/444186/when- Inc. 2014. “The Economic, Climate, Fiscal, Power, and Demographic politics-constraints-carbon-pricing-part-3-why-carbon-revenues-are- Impact of a National Fee-and-Dividend Carbon Tax.” Available at: just-imp. http://dv7gcmvxe5e8l.cloudfront.net/wp-content/uploads/2014/09/ The-Economic-Climate-Fiscal-Power-and-Demographic-Impact-of-a- 102. For example, federal support for new drilling techniques helped pave National-Fee-and-Dividend-Carbon-Tax-6.9.14.pdf the way for the U.S. shale gas boom in recent years. See Box 1.1 of Bianco, N. et al. 2014. “Seeing is Believing: Creating a New Climate 114. Carbone, J.C., R.D. Morganstern, R.C. Williams III, and D. Burtraw. Economy in the United States.” Working Paper. Washington, D.C.: August, 2013. “Deficit Reduction and Carbon Taxes: Budgetary, World Resources Institute. Available at: http://www.wri.org/publication/ Economic, and Distributional Impacts.” Washington, D.C.: Resources new-climate-economy. for the Future. Available at: http://www.weathervane.rff.org/RFF/ Documents/RFF-Rpt-Carbone.etal.CarbonTaxes.pdf 103. The Global Commission on the Economy and Climate, Better Growth, Better Climate, Executive Summary. Available at: http://static. 115. McKibbin, W.J., A. Morris, P.J. Wilcoxen, and Y. Cai. July 24, 2012. newclimateeconomy.report/wp-content/uploads/2014/08/NCE_ “The Potential Role of a Carbon Tax in U.S. Fiscal Reform.” Climate ExecutiveSummary.pdf and Energy Economics Discussion Paper. Washington, D.C.: Brookings Institution. Available at: http://tinyurl.com/btkd5xf 104. Bianco, N. et al. 2014. “Seeing is Believing: Creating a New Climate Economy in the United States.” Working Paper. Washington, D.C.: 116. Eisenberg, S., M. Wara, A. Morris, M. Darby, and J. Minor. 2014. “A World Resources Institute. Available at: http://www.wri.org/publication/ State Tax Approach to Regulating Greenhouse Gas Emissions Under the new-climate-economy Clean Air Act.” Washington, D.C.: The Brookings Institution. Available at: http://www.brookings.edu/research/papers/2014/05/22-state-tax- 105. See: Acemoglu, D. et al. and Fischer, C. et al. regulating-greenhouse-gas-clean-air-act-morris

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117. CBO (Congressional Budget Office). 2013. 128. Eisenberg et al., 2014.

118. CBO (Congressional Budget Office). May, 2010. “How Policies to 129. Metcalf, G. 2009. “Designing a Carbon Tax to Reduce U.S. Greenhouse Reduce Greenhouse Gas Emissions Could Affect Employment.” Gas Emissions.” Review of Environmental Economics and Policy, Washington, D.C.: CBO, Available at: http://www.cbo.gov/sites/default/ Vol. 3, Iss. 1, Winter. Available at: http://reep.oxfordjournals.org/ files/05-05-capandtrade_brief.pdf content/3/1/63.full.pdf+html

119. Ibid. According to CBO, “The length of time required for [the economy 130. Morris, A. and A. Mathur. 2014. “A Carbon Tax in Broader U.S. Fiscal to return to full employment] would depend on a number of factors. Reform: Design and Distributional Issues.” Washington, D.C.: The One would be the ability of firms and workers to foresee and act quickly Brookings Institution. Available at: http://www.brookings.edu/research/ on the changes in prices and to implement the changes that would be papers/2014/05/22-carbon-tax-in-broader-us-fiscal-reform-morris required in their output, training, and other activities. Another factor would be the extent to which shrinking industries are concentrated 131. Rosenbaum, D., S. Parrott, and C. Stone. October, 2009. “How Low- in small communities in which other opportunities for employment Income Consumers Fare in the House Climate Bill.” Washington, D.C.: are limited, requiring laid-off workers to relocate in order to find Center on Budget and Policy Priorities. Available at: http://www.cbpp. new employment. The U.S. economy has adjusted fairly quickly to org/files/7-8-09climate.pdf past changes in the economic environment, including the changes brought about by the rapid development of computer and information 132. U.S. Department of Transportation, Federal Highway Administration. technologies, which destroyed many jobs but created many others, and “State and Urbanized Area Statistics.” Available at: http://www.fhwa.dot. the increase in international trade, which shifted many manufacturing gov/ohim/onh00/onh2p11.htm Accessed on December 11, 2014. jobs out of the country but probably contributed to the growth of 133. U.S. Energy Information Administration. “Electricity: Detailed State service jobs.” Data.” Available at: http://www.eia.gov/electricity/data/state/ Accessed 120. Chateau et al., 2011. on December 11, 2014.

121. Rausch, S., and J. Reilly. August, 2012. “Carbon Tax Revenue and the 134. U.S. Energy Information Administration. “Household heating fuels vary Budget Deficit: A Win-Win-Win Solution?” MIT Joint Program on the across the country.” Available at: http://www.eia.gov/todayinenergy/ Science and Policy of Global Change. August 2012. Cambridge, MA: detail.cfm?id=3690. Accessed on December 11, 2014. Massachusetts Institute of Technology. Available at: http://18.7.29.232/ 135. CBO, 2013. bitstream/handle/1721.1/72548/MITJPSPGC_Rpt228.pdf?sequence=1 136. Pew Center, 2009. Available at: http://www.c2es.org/docUploads/ 122. For more information on the decline of coal-reliant communities in policy-memo-allowance-distribution-under-waxman-markey.pdf recent decades, see: http://www.washingtonpost.com/blogs/wonkblog/ wp/2013/11/04/heres-why-central-appalachias-coal-industry-is-dying/ 137. Morris and Mathur, 2014.

123. See, for example: Dower, R. and M.B. Zimmerman. 1992. “The Right 138. Hassett, K., A. Mathur, and G. Metcalf. 2009. “The Incidence of a U.S. Climate for Carbon Taxes: Creating Economic Incentives to Protect the Carbon Tax: A Lifetime and Regional Analysis.” The Energy Journal. Atmosphere.” Washington, D.C.: World Resources Institute. Available at: Vol. 30, No.2. Available at: https://www.aeaweb.org/assa/2009/retrieve. http://www.wri.org/sites/default/files/pdf/rightclimateforcarbontaxes_ php?pdfid=346 bw.pdf. Dower and Zimmerman find that poorer households spend as much as five times as much on energy as do richer households, when 139. Williams III, R., H. Gordon, D. Burtraw, J. Carbone ,and R. Morganstern. measured as a percentage of income October, 2014. “The Initial Incidence of a Carbon Tax Across U.S. States.” Washington, D.C.: Resources for the Future. Discussion Paper. 124. CBO (Congressional Budget Office). May 2013. “Effects of a Carbon Available at: http://www.rff.org/RFF/Documents/RFF-DP-14-25.pdf Tax on the Economy and the Environment.” Washington, D.C.: Available at: http://www.cbo.gov/sites/default/files/44223_Carbon_0.pdf 140. For example, in 2012, the United States consumed 3.8 billion megawatt-hours of electricity. Of that total, less than 60 million 125. Marron, D. and E. Toder. February, 2013. “Carbon Taxes and Corporate megawatt-hours were imported from Canada or Mexico. See: http:// Tax Reform.” Washington, D.C.: Urban-Brookings Tax Policy Center. www.eia.gov/electricity/annual/html/epa_02_02.html and http://www. Available at: http://www.taxpolicycenter.org/UploadedPDF/412744- eia.gov/electricity/annual/html/epa_02_13.html Carbon-Taxes-and-Corporate-Tax-Reform.pdf 141. EPA (U.S. Environmental Protection Agency). December 2, 2009. “The 126. Mathur, A. and A. Morris. 2012. “Distributional Effects of a Carbon Effects of H.R. 2454 on International Competitiveness and Emission Tax in Broader U.S. Fiscal Reform.” Washington, D.C.: The Brookings Leakage in Energy-Intensive Trade-Exposed Industries.” Washington, Institution. Available at: http://www.brookings.edu/~/media/research/ D.C.: EPA. Available at: http://www.epa.gov/climatechange/Downloads/ files/papers/2012/12/14%20carbon%20tax%20fiscal%20reform%20 EPAactivities/InteragencyReport_Competitiveness-EmissionLeakage.pdf morris/14%20carbon%20tax%20fiscal%20reform%20morris.pdf 142. Metcalf, G.E. 2010. “Submission on the Use of Carbon Fees to 127. Williams III, R., H. Gordon, D. Burtraw, J. Carbone, and R. Morgenstern. Achieve Fiscal Sustainability in the Federal Budget.” Submission August, 2014. “The Initial Incidence of a Carbon Tax Across Income to Commission. Available at: http://works.bepress.com/gilbert_ Groups.” Washington, D.C.: Resources for the Future. Available at: metcalf/86 http://www.rff.org/RFF/Documents/RFF-DP-14-24.pdf

WORKING PAPER | April 2015 | 53 143. See: “WTO Signals Backing for Border Taxes.” Financial Times, June 148. Gravelle, J. January 6, 2014. “International Corporate Tax Rate 25, 2009. Available at: http://www.ft.com/intl/cms/s/0/1be7d034-61b6- Comparisons and Policy Implications.” Washington, D.C.: 11de-9e03-00144feabdc0.html#axzz3Vaj4M5MQ Congressional Research Service. Available at https://www.fas.org/sgp/ crs/misc/R41743.pdf 144. For GATT rules, see: http://www.wto.org/english/docs_e/legal_e/ gatt47_e.pdf 149. See: http://www.finance.senate.gov/issue/?id=8b4a11ec-b93f-43bd- 8f72-fbc4f4768989 145. See, for example: http://papers.ssrn.com/sol3/papers.cfm?abstract_ id=2026879 and http://www.gmfus.org/wp-content/blogs.dir/1/ 150. Bianco, N. et al. 2013. For the United States’ commitment to reduce its files_mf/1374767060Hillman_CarbonTaxes_Jun13_web.pdf For emissions by 83 percent below 2005 levels by 2050, see: “United States an alternate viewpoint, see: http://www.brookings.edu/~/media/ Submission to the Copenhagen Accord, Appendix 1,” United States events/2008/6/09%20climate%20trade/2008_bordoff.pdf. For a Department of State, January 28, 2010, http://unfccc.int/files/meetings/ summary of challenges to WTO compliance, see http://papers.ssrn. cop_15/copenhagen_accord/application/pdf/unitedstatescphaccord_ com/sol3/papers.cfm?abstract_id=2163203 app.1.pdf

146. See Holzer et al. 151. See, for example: Coral Davenport and Marjorie Connelly. January 30, 2015. “Most Republicans Say They Back Climate Action, Poll Finds.” 147. For a discussion of the challenges surrounding how to determine the The New York Times. http://www.nytimes.com/2015/01/31/us/politics/ carbon content of imported goods, see: http://www.iisd.org/pdf/2008/ most-americans-support-government-action-on-climate-change-poll- cph_trade_climate_carbon.pdf finds.html?_r=0

152. Source: Sumner et al., 2009.

54 | Putting a Price on Carbon: A Handbook for U.S. Policymakers

WORKING PAPER | April 2015 | 55 ACKNOWLEDGMENTS ABOUT WRI The authors would like to thank the following individuals for their valuable World Resources Institute is a global research organization that turns big insights and critical reviews of this work: Bradley Abelow, Sam Adams, Juan ideas into action at the nexus of environment, economic opportunity and Carlos Altamirano, David Bailey, Christina DeConcini, Greg Dotson, Craig human well-being. Hanson, Karl Hausker, Dave Hawkins, Bob Inglis, David Jenkins, Nat Keo- hane, Tom Kerr, Noah Kirsch, Ray Kopp, John Larsen, Eli Lehrer, Kelly Levin, Our Challenge Larry Linden, Aparna Mathur, Michael McCormick, Eliot Metzger, Jennifer Natural resources are at the foundation of economic opportunity and human Morgan, Helen Mountford, Derek Murrow, Alex Perera, Kevin Rennert, Danny well-being. But today, we are depleting Earth’s resources at rates that are not Richter, Roger Ullman, Laura Malaguzzi Valeri, and Gernot Wagner. sustainable, endangering economies and people’s lives. People depend on clean water, fertile land, healthy forests, and a stable climate. Livable cities The authors would also like to thank Emily Matthews for copyediting and and clean energy are essential for a sustainable planet. We must address proofreading. In addition, we thank Carni Klirs, Julie Moretti, and Hyacinth these urgent, global challenges this decade. Billings for publication layout and design. Funding for this project was pro- vided by the Linden Trust for Conservation. While our reviewers were very Our Vision generous with their time and advice, this working paper represents the views We envision an equitable and prosperous planet driven by the wise manage- of the authors alone. ment of natural resources. We aspire to create a world where the actions of government, business, and communities combine to eliminate poverty and sustain the natural environment for all people. ABOUT THE AUTHORS Our Approach Kevin Kennedy is deputy director of the U.S. Climate Initiative in the Global COUNT IT Climate Program. He directs the research and manages the staff of the Initia- We start with data. We conduct independent research and draw on the latest tive, which is working to make the economic, technical, and political case for technology to develop new insights and recommendations. Our rigorous deep emissions reductions in the U.S. in the coming decades. Prior to joining analysis identifies risks, unveils opportunities, and informs smart strategies. WRI, Kevin led the Office of Climate Change as Assistant Executive Officer at We focus our efforts on influential and emerging economies where the future the California Air Resources Board. In this role, he oversaw implementation of of sustainability will be determined. the California Global Warming Solutions Act of 2006, including development of California’s cap-and-trade program and the range of other measures the CHANGE IT state is using to reduce greenhouse gas emissions. We use our research to influence government policies, business strategies, Contact: [email protected] and civil society action. We test projects with communities, companies, and government agencies to build a strong evidence base. Then, we work with Michael Obeiter is a Senior Associate in WRI’s Global Climate Program. As partners to deliver change on the ground that alleviates poverty and strength- a member of the U.S. Climate Initiative, he works to advance climate and clean ens society. We hold ourselves accountable to ensure our outcomes will be energy policies at the national level. His work focuses on methane emissions bold and enduring. from natural gas, power plant standards, and carbon taxes. Prior to joining WRI, Michael was the analyst for energy and environment for the Senate SCALE IT Budget Committee. We don’t think small. Once tested, we work with partners to adopt and Contact: [email protected] expand our efforts regionally and globally. We engage with decision-makers to carry out our ideas and elevate our impact. We measure success through government and business actions that improve people’s lives and sustain a Noah Kaufman is an economist for the U.S. Climate Initiative in the Global healthy environment. Climate Program. The focus of his work is on carbon pricing and other market-based climate change solutions. Noah also works on projects related to the economic impacts of climate change and assists WRI’s Economics Team with its work across the organization. Prior to joining WRI, Noah worked for the Environment Practice at NERA Economic Consulting. He specialized on projects related to the economics of environmental and energy policies, as well as evaluating the impacts to the economy and to the electricity grid of infrastructure investments and energy policies. Contact: [email protected]

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